Wage Risk, On-the-job Search and Partial Insurance

This paper contributes to the growing literature on modeling individual wage dynamics. I build and estimate an error component model of wage process jointly with a structural life-cycle model of job mobility in an economy with search friction and job-switching cost. Besides separating shocks by their persistence, I distinguish two sources of wage shocks: shocks at worker-firm level and shocks at individual level which apply to all firms and matches. Contributions of this approach are twofold. First, I show that worker's job-job transition serves as a valuable channel for employed workers to self-insure against match level wage shock. This channel of insuring wage shock is more valuable for low-wage workers. Second, the model is capable of recovering true wage risk that workers experience prior to self-insurance through job mobility. Observed wage changes are after job mobility decisions and hence are different than the true shocks that occur prior to job mobility. Preliminary estimation results suggest that match level wage shock is the dominating permanent wage risk facing workers. The insurance value of on-the-job search is substantial, and is more valuable for young workers and workers whose switch cost is low.