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Wage Volatility and Changing Patterns of Labor Supply

Over the past few decades, the skilled-unskilled hours differential for US men increased when the skill premium rose sharply, which contrasts with previous studies suggesting dominant income effects. We explore increases in wage volatility to resolve this discrepancy. Using the PSID, we document that skilled men experienced much larger increases in wage volatility than unskilled men. Feeding in these wage processes, our general equilibrium incomplete markets model successfully replicates the increased hours differential. We find that hours adjustment is important for self-insurance in the short run, whereas precautionary savings play the dominant role in the long run.


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