The Role of Effort for Self-Insurance and Its Consequences for the Wealth Distribution

I explore the effect of effort as a mechanism to alleviate the idiosyncratic risk faced by individuals in the presence of incomplete markets. I construct a DSGE model where costly effort determines the probability of being employed the next period and a riskless asset can be used to smooth consumption. I first show how effort and assets are inverse related, and that a unique stationary equilibrium exists. Then, in a calibrated version of the model to the US economy, I show that in the stationary equilibrium a positively skewed wealth distribution arises, which is closer to the observed data and has not been obtained by models without ex-ante heterogeneity. I then use the model to evaluate the effect of unemployment insurance on the wealth distribution.

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