Earnings Risk and Occupational Choice

The question of how do people choose occupations has puzzled economists. Occupational choice has been analyzed in terms of a variety of factors. However, occupational choices have not been analyzed fully in the context of risk. Individuals differ in their risk preferences and one of the risks associated with an occupation is the earnings risk, which is defined as the variance of wages within an occupation. The literature on earnings risk is relatively new and provides evidence in support of a positive compensating wage differential associated with earnings risk. Yet, none of these studies examine how earnings risk affects occupational choices. In my dissertation I look at how earnings risk affects occupational choice. A model of compensating wage differential and workers occupational choice and sorting in the light of earnings risk is developed. This model is tested empirically using conditional logit technique on the data from the Merged Outgoing Rotation Group File (CPS-NBER Extract) and the Dictionary of Occupational Titles (DOT). The empirical evidence supports the hypothesis that earnings risk has a negative effect on occupational choice. The effect of predicted wages on occupational choice is positive. The study also examines the effect of various occupational attributes. Among occupational attributes intellect requirement has a negative effect on occupational choice, while specific vocational preparation has a positive effect on occupational choice. Environmental condition is found to adversely affect occupational choice; however, physical demand has a positive effect on occupational choice. The dissertation also controls for the issue of self-selection in calculating earnings risk and assess the bias in the earnings risk premium that arises due to omission of self-selection. It is found that risk premium is underestimated if self-selection is ignored. The results of the model are quite interesting and appealing. In future the plan is to extend the study by including a measure of skewness of the wage distribution and unemployment risk in the occupational choice model.