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Title: Risk and Return Tradeoffs in Lifetime Earnings

Citation Type: Miscellaneous

Publication Year: 2012

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Abstract: There is a tradeoff between risk and expected earnings across occupations. Virtually all occupations require workers to invest in specific skills that tie them to that occupation, but workers face uncertainty about how much they can earn over a lifetime of that type of work. Rational, risk-averse workers will require higher average compensation to enter riskier occupations. This paper estimates the parameters of a model of occupation, labor supply, and consumption choices over the lifecycle with multiple sources of occupation-specific earnings andemployment uncertainty. The estimated model is used to simulate possible lifetime earnings streams for identical workers starting the same occupation and to calculate the expected lifetime earnings from starting in each occupation and the variance around that expectation. The relationship between the expected value and variance of lifetime earnings shows that compensation for earnings risk is a key explanation of variation in expected lifetime earningsacross careers. The measured slope of the risk-return tradeoff is consistent with compensation for earnings risk under reasonable assumptions about the degree of workers risk aversion. As a source of lifetime earnings risk, idiosyncratic, persistent shocks to earnings dwarf business-cycle frequency, occupation-wide shocks. Employment risk, particularly the possibility of changingoccupations and losing the earnings effects of accumulated specific skills, is also an important determinant of lifetime earnings risk.

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Authors: Dillon, Eleanor Wiske

Publisher: University of Michigan

Data Collections: IPUMS CPS

Topics: Labor Force and Occupational Structure, Other

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