Wage Dispersion and Preferred Workers: An Insider-Outsider Search Theoretic Model of the Labor Market

Abstract

In this paper, we construct a search theoretic model that allows for heterogeneous attachment to the labor market in order to explain wage dispersion. We solve for the invariant wage distribution analytically. We also use a Markov chain to numerically solve a discretized version of the model by solving for the transition probability between unemploy- ment and the di erent wage states. Finally, we apply this model to U.S. wage data, using a generalized method of moments approach to estimate the parameters. Compared to the data, our model overestimates wage dispersion, placing excess density at the lower end of the distribution. However, the addition of density in the upper tail relative to the tradi- tional on-the-job search model matches the fat tails found in the data as shown by the ratio of wages at the upper end and lower end of the wage distribution, particularly for the 90-10 and 99-10 ratios.