Overview

We propose a theory that analyzes how a workers’ asset holdings affect their job productivity. In a labor market with uninsurable risk, workers choose to direct their search to jobs that trade off productivity and wages against unemployment risk. Workers with low asset holdings have a precautionary job search motive, they direct their search to low productivity jobs because those offer a low risk at the cost of low productivity and a low wage. We show that such sorting occurs under a condition closely related to Decreasing Absolute Risk Aversion and that the presence of consumption smoothing can reconcile the directed search model with negative duration dependence on wages, a robust empirical regularity that the canonical directed search model cannot rationalize. We calibrate the infinite horizon economy and find that this mechanism is quantitatively important. We evaluate a tax financed unemployment insurance (UI) scheme and how it affects welfare. Aggregate welfare is inverted U-shaped in benefits: the insurance effect UI dominates the incentive effects for low levels of benefits and vice versa for high benefits. Also, when UI increases, total production falls in the economy while worker productivity increases. Finally, we compare a one-off severance payment with per period benefits and find that per period benefits generate superior welfare.