Worker heterogeneity and labor market volatility in matching models

Shimer demonstrated that aggregate productivity shocks in a standard matching model cause fluctuations in key labor market statistics-such as the job-finding rate, the vacancy/unemployment ratio, and the unemployment rate-that are too small by an order of magnitude [Shimer, R., 2005. The cyclical behavior of equilibrium unemployment and vacancies. American Economic Review 95 (1) 25-49]. This paper shows that when the standard model is extended to allow for worker heterogeneity, it exhibits considerably greater volatility. In the model, marginal workers, whose productivity only slightly exceeds the value of their alternative use of time, constitute a disproportionate share of unemployment on average, and that share rises when aggregate conditions deteriorate. These composition effects cause firms to open fewer vacancies during downturns. (C) 2007 Elsevier Inc. All rights reserved.