Termination of Dynamic Contracts in an EquilibriumLabor Market Model (2008 update)

In an equilibrium model of the labor market, workers and firms enter intodynamic contracts that can potentially last forever, but are subject to optimalterminations. Upon termination, the firm hires a new worker, and the workerwho is terminated receives a termination contract from the firm and is then freeto go back to the labor market to seek new employment opportunities and enterinto new dynamic contracts. The model permits only two types of equilibriumterminations that resemble, respectively, the two kinds of labor market separationsthat are typically observed in practice: involuntary layoffs and voluntaryretirements. The model allows for the simultaneous determination of a largeset of important labor market variables including equilibrium unemploymentand labor force participation. An algorithm is formulated for computing themodel’s equilibria. I then simulate the model to show quantitatively that themodel is consistent with a set of important stylized facts of the labor market.[...]