Andreas Fagereng, Luigi Guiso, Luigi Pistaferri, 14 February 2016

There are some risks that households cannot insure against or avoid. These are often called ‘background risks’, with the most prominent being labour income risk. In this column, the authors revisit the importance of background risk for portfolio allocation. Addressing some limitations in the current literature, they find that the marginal effect of background risk is much larger than previously thought. Overall, the economic importance of human capital risk crucially hinges on the insurance role of the firm and the amount of assets available to the individual to buffer labour income shocks.

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