Comparative Advantage and Risk Premia in Labor Markets

German Cubas and Pedro Silos
Working Paper 2012-15
October 2012

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Using the Survey of Income and Program Participation (SIPP), we document a significant and positive association between earnings risk (both permanent and transitory) and the level of earnings across 21 industries. We propose an equilibrium framework to analyze the interplay between earnings volatility and the distribution of skills across workers in determining a relationship between earnings and risk. We use the model to decompose how much of the empirical correlation represents compensation for risk and how much represents selection. The positive association between permanent risk and earnings is compensation for risk, but selection is responsible for the observed relationship between temporary risk and the level of earnings.

JEL classification: E21, E24, J24, J31

Key words: selection, compensating differential, precautionary savings, earnings inequality

The authors thank Gustavo Canavire for his excellent research assistance and Yongsung Chang, Mark Bils, Fernando Borraz, Christopher Carroll, Juan Dubra, Juan Carlos Hatchondo, Georgui Kambourov, David Lagakos, Martin Lopez-Daneri, B. Ravikumar, Victor Rios-Rull, Cesare Robotti, Richard Rogerson, Yongseok Shin, Gustavo Ventura, and Ron Warren for their comments and suggestions and seminar participants at dECON FCE-UDELAR, the Central Bank of Uruguay, Atlanta Fed, NBER Summer Institute EFACR, St. Louis Fed, University of Iowa, and the University of Georgia. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to German Cubas, Research Department, Central Bank of Uruguay, Diagonal Fabini 777, Oficina 501, Montevideo, Uruguay CP 11100, Uruguay,, or Pedro Silos, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8630,

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