Hidden Wealth, Unemployment Insurance, and Employment Duration: The Optimal Shape of UI Benefits in the Presence of Layoff Risk

We provide a characterization of the optimal UI scheme in the presence of layoff risk and hidden wealth. The optimal transfer scheme we propose is such that unemployed agents are liquidity constrained and re-employment taxes are independent of previous employment history. Past history is however reflected by the optimal choice of the initial replacement rate, just after displacement. This payment depends both on previous unemployment history, and on the length of the last employment spell. We show that optimality requires UI transfers to decrease forever after the first period. We also study quantitatively the optimal scheme in an (extended) empirically plausible model.