The Labour Income Risk Associated with the Occupational Choice
Thorsten Heimann
The value of human capital critically depends on two factors: the person’s skills and the economic environment, both of which are exposed to a substantial risk of future deterioration. In particular, changes in the economic environment are uninsurable. An individual takes the risk that, after having made substantial human capital investments in an occupation, the overall earnings level in that occupation performs significantly worse than in others. This decline in earnings capabilities reduces the value of the occupation-specific human capital. Dispersing this kind of risk would be desirable for various reasons. A Monte Carlo simulation then allows to approximate the future earnings distribution of a person with a specific initial occupation. It turns out that the whole earnings distribution changes its shape over time, reflecting the rise in uncertainty about future earnings for longer time intervals. The simulated earnings distribution can be used as a basis to ultimately price financial instruments aiming at the occupational earnings risk, i.e. to determine insurance or option premiums. The actual pricing is yet beyond the scope of this work.
