How Risk Averse and how Prudent are Workers?

Abstract

Analogous to the widely studied concept of precautionary savings, our study contributes to the burgeoning literature on precautionary labor supply behavior when wages are subject to uninsurable wage risk. We estimate the parameters of a dynamic structural model of labor supply of men. We test whether workers are risk averse and prudent in the sense that they increase labor supply in anticipation of higher wage risk. The specification provides a direct test of the widely used CRRA utility function and could identify the Frisch elasticity. Using data from the Panel Study of Income Dynamics (PSID) and the German Socio-Economic Panel (SOEP), we are able to replicate the findings of the previous literature. However, with an extended specification that includes variability of leisure and wage, we reject restrictions implied by CRRA utility for both countries.