Do Wages Really Compensate for Risk Aversion and Skewness Affection?

Utility theory suggests that foreseeable risk should increase the compensation for work. This paper expands on this notion: on basis of utility theory, people should care not only about risk but also about the skewness in the distribution of the compensation paid. In particular, because the degree of risk aversion ought to decrease with income, people should appreciate a small chance of a substantial gain; they should exhibit an “affection” for skewness. To test these hypotheses, this paper carefully develops various measures of risk and skewness by occupational/educational classification of the worker and finds supportive evidence: wages rise with occupational earnings variance and decrease with skewness. In order to identify the discount rate and the degree of risk aversion, we also apply structural modelling of education and occupational choice and allow for non-lognormal wage distributions. JEL code: D8, J3 FILE: wagerisk.15dec01.DOC; first draft June 1999; this version 15 December 2001 Comments given by Coen Teulings, Barbara Wolfe and participants at seminars in Amsterdam, Bonn (IZA), München (SELAPO), Christchurch, New Zealand (University of Canterbury), Auckland, Canberra (ANU), Athens (University of Economics and Business), Dallas (SMU) and Aberdeen are gratefully acknowledged. Work on this project was supported by Vijverberg’s visit to SCHOLAR, Amsterdam (Summer 1999, 2001) and by our joint visit to IZA (Summer 2000). Financial support by NWO, the Dutch Science Foundation, is also gratefully acknowledged.