Idiosyncratic Risk and Aggregate Employment Dynamics

56 Pages Posted: 30 Sep 2000 Last revised: 10 Mar 2021

See all articles by Jeffrey R. Campbell

Jeffrey R. Campbell

University of Notre Dame; Tilburg University

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department

Date Written: October 2000

Abstract

This paper studies how producers' idiosyncratic risks affect an industry's aggregate dynamics in an environment where certainty equivalence fails. In the model, producers can place workers in two types of jobs, organized and temporary. Workers are less productive in temporary jobs, but creating an organized job requires an irreversible investment of managerial resources. Increasing productivity risk raises the value of an unexercised option to create an organized job. Losing this option is one cost of immediate organized job creation, so an increase in its value induces substitution towards cheaper temporary jobs. Because they are costless to create and destroy, a producer using temporary jobs can be more flexible, responding more to both idiosyncratic and aggregate shocks. If all of an industry's producers adapt to heightened idiosyncratic risk in this way, the industry as a whole can respond more to a given aggregate shock. This insight is used to better understand the observation from the U.S. manufacturing sector that groups of plants displaying high idiosyncratic variability also have large aggregate fluctuations.

Suggested Citation

Campbell, Jeffrey R. and Fisher, Jonas D. M., Idiosyncratic Risk and Aggregate Employment Dynamics (October 2000). NBER Working Paper No. w7936, Available at SSRN: https://ssrn.com/abstract=244034

Jeffrey R. Campbell (Contact Author)

University of Notre Dame ( email )

United States

Tilburg University ( email )

Tilburg, 5000 LE
Netherlands

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States

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