How Close to an Auction Is the Labor Market? Employee Risk Aversion, Income Uncertainty, and Optimal Labor Contracts

Section I of this paper develops a model of income insurance in the labor market. The model differs from those of previous analyses in its focus on quantitative implications regarding the degree to which wages diverge from marginal value products, both in time-series and in cross-section data. Sections II and III present empirical evidence consistent with these implications. The main empirical finding is that of short-term divergence, but long-term equality between wages and marginal value products. The labor market appears to differ from an auction market only in the short run, but this short-run divergence considerably reduces the potential variability of employees' realized wealth.