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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. This contrasts with previous studies suggesting dominant income effects. Based on PSID data, we show that skilled men experienced much larger increases in wage volatility than unskilled men. With the rise in volatility in the wage processes, our general equilibrium incomplete markets model replicates the increased hours differential despite the increased skill premium. We find that hours adjustment is important for self-insurance in the short run, whereas precautionary savings play a crucial role in the long run.


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