Uncertainty, Unemployment Insurance, Individual's Optimal Stopping Time and Duration of Unemployment
Posted: 31 Mar 2013
Date Written: March 28, 2013
Building on the tools developed for American call options in financial markets and the optimal timing of investment under uncertainty in economics, this paper proposes a stylized equilibrium model to study the optimal time for a risk-averse unemployed individual, who receives an unemployment insurance benefit and may receive a recall from the old job, to exit from a waiting (and hence unemployment) state and start a new job. It is shown that as a result of the individual’s exercising the optimal timing strategy, there is a duration of “waiting” and that this duration is affected by a number of economic factors, prominent among which are uncertainty on the part of the unemployed individual and the attitude of this individual toward risk.
Keywords: Unemployment insurance, income, utility function, Brownian motions, search, waiting, exit, continuation region
JEL Classification: D81, D84, E24
Suggested Citation: Suggested Citation