School of Economics and Finance

No. 795: Job Displacement Risk and Severance Pay

Marco Cozzi , University of Victoria
Giulio Fella , Queen Mary University of London

May 4, 2016

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This paper is a quantitative, equilibrium study of the insurance role of severance pay when workers face displacement risk and markets are incomplete. A key feature of our model is that, in line with an established empirical literature, job displacement entails a persistent fall in earnings upon re-employment due to the loss of tenure. The model is solved numerically and calibrated to the US economy. In contrast to previous studies that have analyzed severance payments in the absence of persistent earning losses, we find that the welfare gains from the insurance against job displacement afforded by severance pay are sizable.

J.E.L classification codes: E24, D52, D58, J65

Keywords:Severance payments, Incomplete markets, Welfare