Risk-averse firms and employment dynamics

In a turnover-training model, where firms fix high wages to lower worker turnover, we find that high risk-aversion in firms speeds up the adjustment process of unemployment to its natural levels when employers face either temporary or permanent shocks. Therefore, risk aversion has a stabilizing affect on the macroeconomy. This result complements the existing explanations for unemployment persistence. It also raises a general point concerning the wide-spread assumption of risk-neutrality on the part of firms in the real business cycle and New Keynesian DSGE literatures. Our analysis suggests that this is not an innocuous assumption for assessing fluctuations and the appropriate policy response. Assuming firms to be risk-neutral understates their self-stabilization characteristics and therefore leads to an exaggerated stabilization role for monetary and fiscal policies. Copyright 2010 Oxford University Press 2009 All rights reserved, Oxford University Press.