Insurance within the firm

We evaluate the allocation of risk between firms and their workers using matched employer-employee panel data. Unlike previous contributions, this paper focuses on idiosyncratic shocks to the firm, which are the correct empirical counterpart of the theoretical notion of diversifiable risk. We allow for both temporary and permanent shocks to output and find that firms absorb temporary fluctuations fully but insure workers against permanent shocks only partially. Risk-sharing considerations can account for about 15 percent of overall earnings variability, the remainder originating from idiosyncratic shocks to individual workers. Our welfare calculations indicate that firms are an important vehicle of insurance provision.