Self-Insurance and Welfare in Turbulent Labor Markets

We investigate the welfare consequences of turbulence risk|the risk of skill loss coinciding with involuntary layoffs on the labour market outcomes in the presence of imperfect ?nancial markets and search frictions. We build a tractable dynamic heterogeneous agents model with directed search, imperfect ?nancial markets, and uninsurable persistent labor market risk. We calibrate our model to the US economy, matching new empirical facts on the joint impact of turbulence risk and wealth on re-employment wages and unemployment duration. We measure the welfare loss of unemployment transitions and quantify the impact of each channel. We ?nd the fall in wealth upon re-employment has the highest impact on welfare changes among the other channels. Finally, we examine the welfare gain from alternative policies.