Review of Economic Dynamics 16 (2013) 540552

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Review of Economic Dynamics

www.elsevier.com/locate/red

Frictional wage dispersion with Bertrand competition:

An assessment
Tams K. Papp 1
Institute for Advanced Studies, Stumpergasse 56, 1060 Vienna, Austria

a r t i c l e i n f o a b s t r a c t

Article history: I examine whether a version of the Cahuc et al. (2006) model can match the magnitude of
Received 18 September 2009 wage dispersion, as measured by the ratio of the average and the lowest wage the so-
Revised 31 January 2013 called mean-min ratio of Hornstein et al. (2011). I nd that the workers bargaining power
Available online 24 February 2013
is a crucial parameter: the mean-min ratio strictly decreases in the bargaining power up
JEL classication:
to a point near 1/2 and is essentially at thereafter, generating the same amount of wage
E24 dispersion as the canonical wage ladder model, which is a special case of the CPVR model.
J24 Consequently, this model can yield large wage dispersion only for low bargaining power
J31 on the workers side. I show that the share of job-to-job transitions with wage drops is
J6 decreasing in the bargaining power, calibrate the latter to the former, and demonstrate
J64 that the CPVR model generates an empirically plausible amount of wage dispersion. I also
show that negative wages arise when workers have no bargaining power, and discuss the
Keywords: implications for the empirical ndings of Postel-Vinay and Robin (2002b).
Wage dispersion 2013 Elsevier Inc. All rights reserved.
Mean-min ratio
Frictions
Labor market

1. Introduction

Wages are dispersed both in cross section and through time. Explaining these differences among workers is one of the
central questions of economics. In a perfectly competitive environment, workers earn different wages only if their marginal
products are different: wage dispersion is the consequence of differences in individuals innate productive skills, education,
work experience, or other forms of human capital. However, the data suggests that observable worker characteristics are not
able to account for all the wage dispersion among workers: Mincerian wage regressions based on cross-sectional data on
individuals use a large set of observable variables, but usually account for only 30% of the cross-sectional wage dispersion.2
Models of frictional labor markets suggest that ex ante homogeneous individuals can end up earning different wages: when
individuals are not able to survey all potential jobs due to search frictions, some will earn higher wages than others simply
because they were more lucky when searching. However, as Hornstein et al. (2011) (HKV) demonstrate, although frictional
labor market models can explain the presence of wage dispersion, calibrated versions of these models are unable to account
for its magnitude. HKV show that the ratio of the average and lowest wages, which they call the mean-min ratio, is a useful

E-mail address: tpapp@ihs.ac.at.

1
I am grateful for comments received at Princeton University and various other seminars. Discussions with Larry Blume, Bjrn Brgemann, Mikael
Carlsson, Wouter den Haan, Christian Haefke, Nobuhiro Kiyotaki, Per Krusell, Iourii Manovskii, Alisdair McKay, Marc Melitz, Monika Merz, Michael Reiter,
Esteban Rossi-Hansberg, Felipe Schwartzman, Christopher Sims, and dm Zawadowski have led to signicant improvements in this work. I am especially
grateful to the editor and the two anonymous referees for their suggestions which led to a substantial revision of this paper. I would like to thank the
Sveriges Riksbank for nancial and research support during the summer of 2008. The customary disclaimer applies.
2
See Mortensen (2005) for a survey of these results.

1094-2025/$ see front matter 2013 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.red.2013.02.002
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 541

statistic for summarizing wage dispersion. Hornstein et al. (2009) estimate the mean-min ratio for various datasets, and nd
that generally it lies between 1.5 and 2.
HKV show that models without on-the-job search are unable to generate a suciently large mean-min ratio in equi-
librium: a large dispersion of wage offers just raises the option value of searching, resulting in a higher reservation wage,
and thus a lower mean-min ratio. On-the-job search breaks this connection to a certain extent: as workers can continue to
search on the job, they do not sacrice the ability to get a higher wage once they accept a job. Nevertheless, HKV demon-
strate that variants of the standard wage ladder models are unable to generate a mean-min ratio that is large enough with
plausible calibrations. They also suggest that a model along the lines of Postel-Vinay and Robin (2002b) (henceforth PVR),
Dey and Flinn (2005) and Cahuc et al. (2006) (henceforth CPVR) should be able to generate a smaller reservation wage and
thus lead to a plausible mean-min ratio.
In this paper I examine the ability of the CPVR model to match the magnitude of the wage dispersion. First, I nd
that the mean-min ratio is a natural and informative summary of the wage dispersion in this model, thus extending the
results of HKV. I show that the mean-min ratio in this model depends mainly on the unemployment benet (captured
by the replacement ratio, the ratio of unemployment benets and the average wage),3 the discount rate, the job nding
and separation rates (which can be calibrated from ow data) and, most importantly, the bargaining power of the worker.
The wage offer distribution only enters via a normalized distribution of rms reservation wages, and the mean-min ratio
is not very sensitive to this normalized distribution. I derive distribution-independent bounds for certain key quantities
that characterize wage dispersion in the model.4 Second, I describe the relationship between the mean-min ratio and the
workers bargaining power: it strictly decreases in bargaining power up to a point, and it is essentially at thereafter. Since
the maximal bargaining power yields the canonical wage ladder model of Burdett (1978), I argue that wage dispersion in
the CPVR model when bargaining power is high is hard to distinguish from a standard wage ladder model. On the other
hand, when the workers bargaining power is low, I demonstrate that the (C)PVR model can deliver negative wages at the
left tail of the wage distribution. I show that this result is not sensitive to the calibration, and is very hard to escape unless
one calibrates to a very high interest rate or replacement ratio. This has implications for the empirical ndings of PVR,
which I discuss. However, a small positive value of the bargaining power eliminates negative wages in the CPVR model
so they are not a serious problem for the general model. Third, having demonstrated that the mean-min ratio is highly
sensitive to the workers bargaining power, I show that it is possible to calibrate the latter from the fraction of job-to-job
transitions resulting in wage drops. I explore various alternative calibrations and demonstrate that the model generates
mean-min ratios which are empirically plausible.
The key to wage dispersion in the (C)PVR model is the backloading of wages, which is a direct consequence of the wage
determination mechanism. When workers in the model encounter another rm while searching on the job, the two rms
rst engage in Bertrand competition with perfect information. The rm which can potentially pay a higher wage can always
match any offer of the other rm with the lower potential wage, which results in the latter offering all of the surplus to
the worker, and the former just making an offer to match that in present value terms. In the CPVR model the worker and
the rm which won the Bertrand competition round then determine the wage using generalized Nash bargaining. Since
rms with a higher potential wage can match more offers or provide a better bargaining position for job-to-job transitions,
working for a rm with a high potential wage is potentially valuable. However, this value is only realized via outside offers,
and thus it is shifted to the future, resulting in lower wages in the present. This introduces a degree of separation between
the highest potential wage in a match and the actual wage that is earned by the worker at the moment: the model is able
to generate a large mean-min ratio because the aforementioned backloading can result in low wages even in high-quality
matches. In the most extreme form of this model, analyzed by PVR, the worker has no bargaining power and the lowest
wages are paid to workers hired from unemployment to a match with a very large potential wage. Consequently, workers
are prepared to accept wages lower than their outside option to enter the job ladder, reducing their reservation wage and
spreading out the wage distribution.
The structure of the paper is as follows. In Section 2, I separate the mean-min ratio into the replacement ratio and a
variable that summarizes the inuence of all the other parameters. Section 3 contains analytical results about the wage
distribution and consequently . In Section 4, I calibrate the model parameters and discuss the quantitative implications of
the model. Section 5 concludes.5

2. The mean-min ratio and the replacement ratio

Let w denote the lowest observed wage and w the average wage. The mean-min ratio is

3
For simpler wording, in this paper I use unemployment benet in the broad sense, also including the value of non-market time.
4
The formulation of the model is in partial equilibrium, which makes the result very general: the relationships that I show between certain (possibly
endogenous) quantities have to hold regardless of the actual mechanism that generates wage dispersion, which could, for example, be rm- or match-
specic productivity, with or without free entry. For the result I only need to assume that for each match, there is a maximum possible wage that the rm
is willing to pay for employing a particular worker.
5
Most proofs and calculations are relegated into the online appendix, which also contains the derivation of the mean-min ratio for a related model of
Carrillo-Tudela (2009), where the rms do not have perfect information but can condition on unemployment. It is shown that this model yields a smaller
mean-min ratio than the Burdett and Mortensen (1998) model. Some calculations were veried with Maxima (2012).
542 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552

w
Mm =
w
and generally depends on various model parameters, such as the labor market transition rates, the interest rate, the unem-
ployment benet, and other parameters characterizing the workers risk aversion and search costs (if any). However, HKV
demonstrate that the unemployment benet plays a crucial role in the sense that for a large class of models, an empirically
plausibly large value of the mean-min ratio can be generated with a small, perhaps negative, value of the unemployment
benet. The intuition behind this result is simple: lowering the unemployment benet makes unemployment less attractive
and thus lowers w , which lowers Mm if w does not decrease proportionally. Consequently, the theoretical challenge is
not in generating a high mean-min ratio per se, but achieving this with a plausible value of the replacement ratio.6 In this
paper I separate the mean-min ratio Mm into two components: the replacement ratio and a value that summarizes the
inuence of all other parameters on the mean-min ratio. Specically, I dene

w b w b
= =
( w b) ( w b) w w
to denote the ratio of the difference between the lowest wage and the unemployment benet b to the difference between
the average and lowest wages. When parameterizing the unemployment benet b in terms of the replacement ratio

b
=
w
we arrive at the expressions
1+ 1 Mm
Mm = and = (1)
+ Mm 1
This is important for models which allow for the determination of w b and w b independently of b, as it allows us
to separate the calibration of (or equivalently, b) from the other parameters that determine . Most models considered
by HKV belong in this category and are readily recognizable as being of the form (1) for some , allowing us to focus the
discussion by comparing for each model instead of considering the mean-min ratio Mm directly. Consequently, in this
paper we will be focusing on the determination and calibration of .
When we calculate for the wage ladder model of Burdett (1978), we nd BM = 2.61 which requires 0.8   0.2
to produce Mm [1.5, 2], the range estimated by Hornstein et al. (2009): as noted by HKV, matching the mean-min ratio
would require negative replacement ratios in this model.7 When w 0, w b = w w implies that and
Mm . This is more than a theoretical curiosity for the (C)PVR model family, since when the bargaining power of the
worker is low wages can be driven well below b, or even zero. We discuss this question in Sections 4.4 and 4.5.

3. Model and theory

I consider steady state partial equilibrium model along the lines of Cahuc et al. (2006).8 Time is continuous. A unit mass
of ex ante identical workers are either unemployed (u) or employed (1 u). Firms differ with respect to the maximum wage
they are able to offer,9 which I refer to as the rms type. Unemployed and employed workers encounter rms at rates
u and e , respectively, drawing rms from the same distribution, which gives them the option of forming a match, with
wages determined according to the bargaining mechanism outlined below. Instantaneous utility is linear in the wage and the
unemployment benet b, and workers discount future earnings at the rate r. Workers die at rate , exiting with termination
value 0, and new workers, starting out as unemployed, enter the labor market every instant. Existing rmworker matches
are terminated for exogenous reasons at rate : workers become unemployed after an exogenous job termination.10 Table 1
summarizes the notation used in this section.
Cahuc et al. (2006) discuss the wage bargaining setup in detail, also providing an alternating offers game that provides
microfoundations for it, here I only summarize the mechanism briey. Employment contracts stipulate constant wages, but
can be renegotiated with the consent of all parties. When an unemployed worker encounters a rm, wages are determined
according to a generalized Nash bargaining setup in which workers get a share of the surplus, and thus the resulting
wage depends only on the type of the rm. When an employed worker, searching on the job, encounters another rm,

6
And consequently, the unemployment benet.
7
Calculations use bounds and calibration from Sections 3 and 4.
8
The model I consider is different from Cahuc et al. (2006) and its special case Postel-Vinay and Robin (2002a) in a few respects. First, I consider only a
linear utility specication. I restrict the specication for tractability, and also because I believe that a utility specication with risk aversion would be easier
to interpret in the context where agents can save and borrow, but it would not be realistic to assume that the rm can observe the wealth of the agents
perfectly when making an offer to unemployed workers. Second, in contrast to PVR, I do not assume individual-specic heterogeneity in productivity. The
reason for this is that I focus on frictional wage dispersion among ex ante homogeneous workers. This also simplies the exposition.
9
Which is the reservation wage from the rms point of view.
10
Below, we shall see that only the sum of and plays a role in the determination of the wages and thus the mean-min ratio, so for most parameter
combinations the introduction of worker death is superuous. However, > 0 allows us to consider the limiting case of r 0.
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 543

Table 1
Notation.

b unemployment benet
w; w, w wages; average and lowest wage in the cross-section
= b/ w, replacement ratio
determines the mean-min ratio when combined with , see (1)
bargaining power of the worker

, ; rates for worker death, job termination rates; sum of the two
u , e job nding rate of unemployed and employed, respectively

F ( p) normalized distribution of types

= u /e 1, excess search eciency of unemployed relative to employed
= r / , interest rate relative to separation rate
= e /
p, q types of current employer and the other rm that last changed the wage
= w b, wages relative to unemployment benet, also used for ( p , q)
, mean and lowest (min) wage, relative to the unemployment benet
G ( p) cross-sectional distribution of p
G (q | p ) conditional cross-sectional distribution of the other rms types

the incumbent and the other rm engage in Bertrand competition for the worker, who then negotiates a wage with the
winning rm using generalized Nash bargaining with the same bargaining parameter , with the outcome of the Bertrand
competition round as the workers outside option, making the wage depend on the types of the two rms only.

3.1. The two-state model

Because the general results in this section are somewhat technical, it is useful to consider a simplied version with only
one rm type. Even though this version of the model does not illustrate all features of the general one, it serves as a simple
introduction to the CPVR model, and provides intuition about how it can generate large wage dispersion via backloading.
There are only two wages in this model: workers coming directly from unemployment earn w 0 , while employed workers
who have already encountered another rm while searching on-the-job earn the highest possible wage w 1 .11 Let U , W 0 and
W 1 denote the present value of being unemployed, working for a rm having bargained from unemployment, and having
encountered another rm while searching on the job, respectively. The HJB equations are

(r + )U = b + u ( W 0 U )
(r + ) W 0 = w 0 + e ( W 1 W 0 ) + (U W 0 )
(r + ) W 1 = w 1 + (U W 1 )
and the bargaining setup imposes W 0 U = ( W 1 U ). These four equations characterize the wages for the model, and
from the transition rates it follows that the share of workers with the lower wage is /( + e ).12 Simple algebra yields
 
r + + e
w 0 b = 1 (1 ) ( w 1 b)
r + + u
When = 1, w 0 = w 1 and we get a canonical wage ladder model (albeit with a single wage) which features no backload-
ing. The maximum amount of backloading is obtained in the PVR model, for which = 0, and
e
w0 b = ( w 1 b)
r+
Intuitively, a worker with wage w 1 discounts the future at rate r and may separate at rate , and consequently his surplus
over unemployment is ( w 1 b)/(r + ). On the other hand, a worker with wage w 0 came into the match with no bargaining
power and consequently his surplus over unemployment is 0: this means the expected increase in surplus, which happens
are rate e , is balanced by a wage that is lower than b.13

3.2. Model with general rm type distribution

In this section I characterize the model with a general, non-degenerate rm type distribution. Recall from Section 2 that
we are interested in characterizing the difference of the wages and the unemployment benet. Let F denote the distribution
of rm types relative to the lowest viable rm type that can form a match with positive surplus, introduce

11
Note that Assumption 1, introduced later in Section 3.2, does not hold in this simplied model, since when the surplus is positive rms with lower
type could also enter, leading to even more wage dispersion. However, this does not matter when = 0, in which case w 0 is the lowest wage.
12
Cf. (4) in Lemma 1.
13
When r 0, w 0 b ( w 1 b)e / and consequently the average wage w is exactly b. Cf. Theorem 1.
544 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552

e r u e
= , = , =
e
and let ( p , q) denote the difference of the wage and the unemployment benet for a worker at a type p rm, having
previously encountered a rm with type q  p or coming from unemployment (q = 0), and introduce the tail integral

 
e F ( p ) F ( p )
I (q) = dp = dp (2)
r + + e F ( p ) + 1 + F ( p )
q q

In online Appendix A, I derive the following characterization of based on the results of CPVR.

Lemma 1.
 
( p , q) = p + (1 )q (1 )2 I (q) I ( p ) + I (0) (3)
and the steady state distribution of ( p , q) is characterized by the distribution functions
 2
F ( p) 1 + F ( p )
G ( p) = , G (q | p ) = (4)
1 + F ( p ) 1 + F (q)
where G ( p ) is the cross-sectional cumulative distribution function of p, and G (q | p ) is the cumulative distribution function of q
conditional on p.

Observe that when = 0 and the worker has no bargaining power, we obtain the PVR model with

p
 
( p , q) = q I (q) I ( p ) = q F ( p ) dp (5)
q

and the lowest unnormalized type is equal to the unemployment benet b. In this model the type of the current employer
only plays a role in the determination of future wages, thus lowering the wage in the present: is increasing in q, but
decreasing in p because of backloading.
The other important special case is = 1, the canonical wage ladder model, in which

( p , q) = p + I (0) (6)
and the difference between the lowest unnormalized rm type and the unemployment benet is I (0). In this model q plays
no role, and is increasing in p. I (0) is the difference between the lowest acceptable rm type and the unemployment
benet, and is positive when the distribution is non-degenerate. A frequently considered special case14 is e = u , which
makes = 0 and ( p , q) = p. In the general case 0   1, this difference is I (0) and plays an important role in our
analytic characterization of the model, as it serves as a useful normalization for .
It is important to note that the distributions G ( p ) and G (q | p ) are independent of , in fact, they are only a function
of F and . One can think of the cross-sectional wage distribution as a result of mapping the distribution dened by G ( p )
and G (q | p ), which are independent of and , using a function which does depend on these quantities. We use this
property when discussing comparative statics in Section 4.
For a general [0, 1], (3) shows that is increasing in q: in other words, the wage is increasing in the type of the
other rm the worker last encountered, regardless of whether that rm is the previous employer or a rm which helped
the worker raise the wage with an outside offer. Clearly, for the lowest wage we have q = 0. On the other hand, looking at
 
( p , 0) = p (1 )2 I (0) I ( p ) + I (0) (7)

we notice that the relation between and p is not so clear: the rst term p is increasing in p, while the term (1 )2 I ( p )
is decreasing in p, so the net effect is ambiguous.
The left panel of Fig. 1 shows the lowest wages as a function of the rank of p for various values of , while the right
panel of the same gure shows the location of the minimum.15 Observe that there appears to be a threshold for , below
which (0, 0) yields the lowest wage, while above this threshold the minimizing p is decreasing in , and spans the whole
distribution. We formalize this statement and characterize this threshold for below, but rst we have to make a technical
assumption to ensure that the lowest is actually assumed in equilibrium.

14
See for example Mortensen (1998).
15
Many of the plots in the paper use quantiles F ( p ) instead of p on the axes. This makes it more convenient to plot distributions or quantities which are
not necessarily constrained to be nite.
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 545

Fig. 1. Left: ( p , 0) as a function of F ( p ) and each line corresponds to a value of = 0, 0.1, . . . , 0.9, 1, from bottom to top, respectively. Right: F ( p )
that minimizes ( p , 0) as a function of . Benchmark calibration.

Assumption 1. The support of the distribution F is convex and contains 0.

Assumption 1 is innocuous: for example, free entry of rms is sucient for it to hold.

Lemma 2. The lowest wage is

    
= min ( p , q) = p (), 0 = I (0) + p () (1 )2 I (0) I p () (8)
p q0

where


0 if 
p () = if = 0 (9)


the solution of F ( p ) = 12 +1

otherwise

and the threshold is dened by

1 1
= = (10)
2 + +1 2 + r+
e

The result demonstrates that the response of the lowest wage to the bargaining share exhibits a dichotomy: for  ,
the lowest wage is always earned by workers at rms of the lowest type who either come from rms of the same type
or unemployment, but when < , backloading dominates and the lowest wage is obtained at an interior p, which is
decreasing in . For the PVR model, = 0 and F ( p ) = 1, obtained in the limit if the support of the distribution is innite.
This dichotomy in the model also affects and consequently the mean-min ratio before we discuss that, we need to
derive an expression for the average .

Lemma 3. The average is


1+ 1+ + F ( p ) F ( p )
= I (0) + I (0) + dp (11)
(1 + F ( p )) + 1 + F ( p )
2
0

The rst term in (11) is simply the wedge I (0) between the unemployment benet b and the lowest unnormalized
type, which comes from the renormalization of wages by b and is present in all forms of here it is simply an expected
value of a constant. When r  and  0, the third term is small, and the rst and the second terms dominate the
expression, which allows us to infer the behavior of by comparing and to the wedge I (0). In the online appendix I
prove that is increasing and thus the mean-min ratio Mm is decreasing in .16 However, we can also show that vs
is nonlinear, especially around = . First, we characterize for = 0, which corresponds to the model introduced by
Postel-Vinay and Robin (2002b).

16
See Lemmas 3 and 5.
546 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552

Theorem 1 (Mean-min ratio for Postel-Vinay and Robin, 2002b). When = 0,

1
= (12)
1 + D ( , F )
where
 (1+ ) F ( p )
dp
0 (1+ F ( p ))2
D ( , F ) =  (13)
0
F ( p ) dp

For all possible distributions F ,

1 + if  1
4
0  D ( F , )  (14)
1
if 0   1
1 +

and for all there exist distributions for which D is equal to the boundaries above.

Next, we show that for  , is nearly constant.

Theorem 2 (Mean-min ratio for  ). When  ,   (), where

u e
() = = and
1+ /
1 + + 1 + e + + r +e /
+e
u e
= =
(1 + )(1 + ) (e + )(1 + r / )

The intuition behind the result is simple: when  , increasing increases both and , but the rst is exactly
and the second is approximately proportional to I (0), so their ratio changes very little and stays within the given bounds.
The upper bound () at = 1 corresponds to the approximation obtained by HKV for the wage ladder model which is a
special case of the CPVR model at = 1. The result also implies that the mean-min ratio is nearly constant for  , and
thus we can only expect to obtain a high mean-min ratio for [0, ]. However, because () has such a large range on
this interval it is important to obtain a reliable calibration for , for which I use the proportion of wage drops in job-to-job
transitions. Here I state a theoretical result that will be useful when calibrating the model.

Theorem 3 (Wage changes).

(a) When  , all job-to-job transitions result in a wage increase, otherwise there are job-to-job transitions that result in a wage
decrease.
(b) Consider workers moving from a job with state (q, s) to another job with ( p , q). For any probability measure H on S = {( p , q, s) |
p  q  s  0}, dene

P = E H ( p , q) > (q, s)

When  , P = 1. When 0  < , P is strictly increasing in .

Note that Theorem 3 is about general measures, which is important because there might be various measures of wage
changes for job-to-job transitions: for example, one might consider all job-to-job transitions within a time interval (e.g.
a year or a quarter), a given instant, or starting from some specied point in time until the observed individuals change
jobs or become unemployed (which is in fact what we will calibrate to), but the result states that we can always expect the
proportion of negative wage changes to decrease with and vanish at .

4. Calibration and results

In this section I calibrate the model and examine its quantitative implications. First I calibrate the transition rates and
the interest rate, which allows the examination of as a function of [0, 1] for various distributions from this exercise
I conclude that per se is not very sensitive to the actual distribution used. The results also serve as an illustration for
Theorems 1 and 2. Then I argue that can be calibrated to the share of negative wage changes that occur on job-to-job
transitions, and examine the resulting values of and Mm. Finally, I conclude this section with a discussion of cross-
sectional distributions and a discussion of some results of Postel-Vinay and Robin (2002b).
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 547

Table 2
Transition rates and the discount rate. Left: rates calibrated to US data, time unit is a month. Right: transformed rates.

u 0.404 job nding rate

3.31
e 0.0937 arrival rate of offers for employed workers
4.30
0.0218 separation rate ( 5% unemployment rate)
0.15
r 0.0033 discount rate ( 4% annually)

Table 3
Distributions. Normal distributions are left-truncated at 0.

Distribution Line style in plots

N [0,) (0, 1) standard normal
N [0,) (2, 1) normal
N [0,) (1, 1) normal
N [0,) (1, 1) normal
N [0,) (2, 1) normal
Exp(1) exponential distribution
U (0, 1) uniform distribution

4.1. Transition rates and the interest rate

Calculating the mean-min ratio for the CPVR model necessitates the calibration of the transition rates e , u and .
The calibration of the latter two is relatively straightforward, but e is not directly observable, as not all encounters of
employed workers with another rm result in a job-to-job transition. However, following Nagypl (2006), we can calibrate
to the average job-to-job transition rate and the separation rate . I use the tabulations of Fallick and Fleischman (2004),
derived from CPS data between January 1994 to December 2003, corrected for time aggregation and converted to continuous
time using a method similar to Shimer (2012).17 Following HKV, I use an annual discount rate of 4%. Table 2 summarizes
the calibration of transition rates and the interest rate. For future reference, note that this calibration implies that
[2.33, 2.61] for the wage ladder model ( = 1), using the bounds from Theorem 2. Also, the implied by Table 2 is 0.44.

4.2. Distributions and

The expressions derived by HKV for various models are mostly distribution-free, which makes their result very general.
Even though I have obtained reasonably tight bounds for for some values of (specically, for {0} [, 1]), I have
not obtained closed-form expressions that are distribution-free. Nevertheless, turns out to be relatively insensitive to the
choice of the distribution.18
In order to demonstrate this, I calculate values for with various distributions. In order to explore the sensitivity of
results to higher moments, I focus on the (truncated) normal family, the exponential distribution (as an example of a
leptokurtic distribution) and the uniform distribution (which is platykurtic), xing the scale to a value that is convenient
for each distribution (e.g. unit variance for normals).19 Table 3 summarizes the distributions and also shows the line styles
used for subsequent plots.
Fig. 2 shows the value of for the distributions in Table 3. First, it is apparent that the value of for a particular is
not very sensitive to the actual distribution: even though higher moments play some role, their inuence is relatively minor.
Second, the plot illustrates the properties of that we have shown analytically in Section 3: in accordance with Theorem 1,
at = 0 is very close to 1, then it is increasing on the range [0, ], and nearly constant (but slightly increasing) for
 . The conclusion we draw from this plot is that while the distribution does not play an important role, the value of
and thus the mean-min ratio is very sensitive to . We calibrate the latter in the next section.

4.3. Calibration of and its inuence on the wage dispersion

The canonical wage ladder model ( = 1) features positive wage changes by construction: wage is the only state variable
that plays a role in the determination of the present discounted value, and a new job only dominates an existing one if the
former pays a higher wage. However, Jolivet et al. (2006) document that a signicant share of workers experience negative
wage changes when moving from one job to another, which is at odds with the predictions of a simple model.
Of course it is very simple to extend wage ladder models so that they generate wage drops for job-to-job transitions.
Workers may be forced leave their current job for exogenous reasons with a certain probability (e.g. spouses getting a job
in a different location), in which case their reservation wage would be the same as the reservation wage for unemployed,

17
The details are available in online Appendix C.
18
In previous versions of this paper I calibrated F to productivity dispersions and then conducted sensitivity analysis, obtaining similar results.
19
Lemma 6 (in the online appendix) shows that and consequently the mean-min ratio are invariant to scaling the distribution F , and thus we are free
to scale our distributions in a manner that is most convenient.
548 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552

Fig. 2. as a function of , for the distributions in Table 3, other parameters as in Table 2. Note that (1) is not sensitive to the choice of distribution,
(2) 1 when = 0 (cf. Theorem 1) and (3) changes very little once  (cf. Theorem 2).

Fig. 3. Proportion of wage drops as a function of (for the distributions in Table 3, other parameters as in Table 2). The dotted vertical line is at = ,
while the solid horizontal line marks 23.3% which Jolivet et al. (2006) document for the US.

which can easily lead to wage drops. Also, jobs may differ in terms of the growth rate of wages, the returns on human
capital, or the non-pecuniary benets that they offer, which can also generate wage drops.
An interesting feature of the CPVR model is that it is able to yield wage drops for workers moving from one job to
another without resorting to any of the devices mentioned above. Workers may experience a wage drop because of back-
loading: they accept an initially lower wage at a new employer in exchange for the possibility of a future wage increase.20
We have shown in Theorem 3 that the probability of wage changes is increasing in and goes to 0 when  , so
calibrating to this measure should be possible if it is high enough at = 0.
Jolivet et al. (2006) show that in the PSID data, 23.3% of job-to-job transitions result in wage drops in particular, they
look at the sign of the rst wage change conditional on an employed working moving from one job to another without
experiencing unemployment in between. We use P( w ) to denote this share, and use simulation for obtaining exactly this
measure for various distributions as a function of , with Fig. 3 showing the result.
The particular value documented by Jolivet et al. (2006) would imply 0.2, however, it is unlikely that all of the wage
drops for job-to-job movements are explained by the mechanism exhibited by this model. Fallick and Fleischman (2004)
show that the workers who actively search on the job (4.4% of all workers) are more than 5 times as likely to become
unemployed compared to the workers who do not report searching on the job, suggesting that a signicant fraction of
job-to-job transitions are forced, which is not captured by the version of the CPVR model we discuss in this paper.21
Consequently I consider other values, in particular P( w ) = 15%, 10%, 5%. We nd the value of that gives the desired
proportion of wage drops for each distribution; the results are shown in the left panel of Table 4. Then we calculate the
corresponding for each distribution, shown in the right panel of the same table.
Clearly, is well-identied by P( w ) given the distribution, but its value does depend on the particular distribution
however, the differences are small, especially as P( w ) gets smaller. This is to be expected, as P( w ) 0 would imply
, where the latter does not depend on the distribution. However, even though the for a given is not very
sensitive to the distribution (cf. Fig. 2), when we calibrate rst and then obtain for the same distribution the is
somewhat sensitive to the choice of distribution. Again, when we target a smaller P( w ), the difference is smaller.

20
However, backloading per se is not sucient for wage drops, see e.g. Shi (2009).
21
Tjaden and Wellschmied (2012) discuss the importance of capturing wage cuts in the context of a job ladder model with a rich structure.
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 549

Table 4
Calibration of (left) and the resulting (right) for various values for the proportion of wage drops (for job-to-job transi-
tions) and distributions.
s, calibrated to the share of wage drops for each combination
P( w ) (%) 23.3 15 10 5 P( w ) (%) 23.3 15 10 5
Exp(1) 0.19 0.27 0.31 0.35 Exp(1) 0.30 1.06 1.55 1.96
U (0, 1) 0.10 0.24 0.30 0.35 U (0, 1) 0.46 0.53 1.12 1.72
N [0,) (2, 1) 0.17 0.26 0.31 0.35 N [0,) (2, 1) 0.12 0.91 1.42 1.89
N [0,) (1, 1) 0.17 0.26 0.31 0.35 N [0,) (1, 1) 0.06 0.86 1.38 1.87
N [0,) (0, 1) 0.16 0.25 0.30 0.35 N [0,) (0, 1) 0.05 0.76 1.29 1.82
N [0,) (1, 1) 0.14 0.24 0.29 0.35 N [0,) (1, 1) 0.20 0.63 1.17 1.74
N [0,) (2, 1) 0.11 0.22 0.28 0.34 N [0,) (2, 1) 0.38 0.44 1.02 1.62

If we calibrate to P( w ) = 23.3%, the resulting s range from 0.30 (for the exponential, which is the most leptokurtic
distribution) to 0.46 (for the uniform, which is the most platykurtic we consider). Recall from Section 2 that when < ,
the model generates negative wages. Shimer (2005) calibrates to = 0.42, which we use as a benchmark. Given this value
of , negative wages do not occur in our model except for the uniform distribution. However, since is still around 0 for
the normal distributions, the mean-min ratio can be very high in this calibration.
Targeting P( w ) = 15% yields between 0.44 and 0.91 for the normal distributions, with = 0.86 for the standard
normal. This delivers a mean-min ratio of Mm = 1.45 with = 0.42, while the two distributions with the most extreme
values yield = 1.06 (Mm = 1.39, exponential) and = 0.44 (Mm = 1.67, truncated normal with mean 2). When P( w )
is lowered further to 10%, we obtain s around 1.3 (Mm = 1.33), and for P( w ) = 5% we get very close to the s that we
would nd in the range of  , basically approximating the mean-min ratio for the canonical wage ladder model.
These results imply that the model can deliver a plausible amount of wage dispersion (as measured by the mean-min
ratio) with an empirically reasonable share of wage drops, especially if one does not believe that all wage drops were
generated by the mechanism featured in this model. While the calibrated is somewhat sensitive to the choice of the
distribution, all values generate more wage dispersion than the canonical job ladder model (recall that BM = 2.61), and
this sensitivity is smaller when we are targeting a lower P( w ).

4.4. Wage distributions and

In this section we examine the cross-sectional wage distributions implied by the model. First, we return to the problem
of negative wages: as discussed briey in Section 2, the model may deliver negative wages. Even though negative wages
are not observed in the data, jobs with a negative net utility ow (e.g. a nonnegative wage, but a negative non-pecuniary
component, such as an internship) cannot be ruled out a priori. Consequently, it is interesting to examine the entire wage
distribution. In this section I consider the model calibrated to the transition rates in Table 2 and calibrate F to the (trun-
cated) standard normal distribution I refer to this as the benchmark calibration.
Previously we have worked with distributions for = w b where w would be the actual wage observed in the data.
In order to relate this to the distributions we discuss, recall that b = w = ( + b) and thus a wage w = + b is negative
when

+ < 0
1
Fig. 4 shows the cross-sectional distributions of the benchmark calibration for various values of . The right panels
show the distributions of in the cross-section (thicker black line) and for the workers hired from unemployment (thicker
gray line) using quantile plots. The dotted, dashed and solid thinner black lines mark the 5%, 25%, 50% quantiles for the
cross-sectional wage distribution. On the left panel, gray dots represent draws from the ( p , q) distributions, where the axes
are transformed to quantiles so that the plots are compact even though the distribution has innite support. Recall from
Section 3.2 that this distribution does not depend on , so we will show the same dots in all plots in this section for
consistency. Finally, the thinner black lines (dotted, dashed, solid) show the iso-wage lines for the same quantiles as in the
right panel.
As discussed before, in the PVR model ( = 0) wages are decreasing in p, and the lowest wage is attained at the highest p
in the distribution. The share of negative wages can be read from the graph approximately: for = 0.42, /(1 ) = 0.72
and the mean (solid thinner line) is very close to the median, so we can get a good approximation about the share of
negative wages by ipping the median around 0 and reading the quantile where it crosses the thicker black line which is
the cross-sectional wage distribution. The actual value is 0.39, so an extremely high proportion of wages are negative. Of
course this depends on , and the smaller is, the lower the share of negative wages, but it is hard to escape negative
wages for = 0 without making interest rates large. Also, the wages of workers hired from unemployment are mostly
negative, too. However, it is very easy to get rid of negative wages by increasing . The second row of Fig. 4 shows the
same plot for = 1/4, here we no longer have negative wages for plausible values of . The plots also illustrate Lemma 2:
wages are no longer monotone in p, and the lowest wage is obtained at some interior p. The middle row shows the same
plot for = 1/2: recall that  1/2, so now we are in a region of the parameter space where all job-to-job changes
550 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552

Fig. 4. Wage distribution for various s. Left: iso-wage lines (dotted: 5%, dashed: 25%, solid: median) and cross-sectional ( p , q) distribution. Right: iso-wage
lines (thin, quantiles the same as before, solid circle shows the lowest wage), quantile plots of cross-sectional wage distribution (black) and wages for
workers hired from unemployment (gray). Benchmark calibration.

result in wage increases, and the mean-min ratio does not differ signicantly from that of the canonical wage ladder model.
However, an important difference between this parameterization and the canonical wage ladder model is that wages are
still increasing in q, so workers can expect wage increases on the job when they get counteroffers. The fourth row shows
the same plots for = 3/4. We are now very close to the canonical wage ladder model: wages are increasing in q, but only
slightly, and the wages for workers hired from unemployment are closer to the cross-sectional distribution. Finally, = 1
yields the canonical wage ladder model, where the wages are invariant to q (vertical iso-wage lines).
Fig. 4 also allows us to compare the wages of workers hired from unemployment with the cross-sectional distribution.
Considering the median of both distributions, it is clear that the difference between the two is greatest when = 0, the
median for workers coming from unemployment is negative and far from the median in the cross section which is
positive. This is because workers hired from unemployment literally have no bargaining power in this parametrization, and
consequently they get wages below b. When = 1/4, both median s are positive, and even the worker with the lowest
wage earns more than b. The distance shrinks further when we go to = 1/2, but does not change signicantly when we
keep increasing from 3/4 to 1, and the shape of the distributions does not change too much either with this change in .
From this we conclude that for high values of even this aspect of the model is also very similar to the canonical wage
ladder model.
 T.K. Papp / Review of Economic Dynamics 16 (2013) 540552 551

Table 5
Model parameters reconstructed from Postel-Vinay and Robin (2002b). e and are 1 and + from their Table IV, converted to monthly rates. r is
from Table V, also converted to monthly, and R annual is the annualized gross interest rate. and are calculated from these according to the denitions in
Lemma 1. I calculate the upper bound for from Theorem 1. The unemployment benet from Table V and the average wage reconstructed from Table VII
(using a lognormal approximation) are used for calculating . The lower bound for the mean-min ratio is then calculated using (1).

Occupation e r R annual max Mmmin

Executives 0.054 0.0070 0.029 1.42 4.17 7.60 0.46 2.05
Supervisors 0.056 0.0077 0.039 1.60 5.10 7.21 0.41 2.05
Technicians 0.054 0.0061 0.030 1.43 4.96 8.87 0.42 1.85
Administrative 0.061 0.0085 0.056 1.97 6.67 7.25 0.35 1.83
Skilled manual 0.057 0.0081 0.037 1.56 4.58 7.08 0.43 1.92
Sales and service 0.060 0.0088 0.048 1.79 5.47 6.75 0.39 1.53
Unskilled manual 0.056 0.0095 0.066 2.22 6.97 5.83 0.33 1.56

4.5. Comparison to Postel-Vinay and Robin (2002b)

Even though they use data for France, not the US, it is instructive to reconstruct an approximation to the mean-min ratio
from the results of Postel-Vinay and Robin (2002b). Table 5 shows the required parameters, the upper bound for (from
Theorem 1) and the resulting lower bound for the mean-min ratio. Even though the latter are somewhat on the high side,
especially for high-skilled workers (recall that these are lower bounds, independent of the distribution, and the actual Mm
will be higher for realistic distributions), they are not outside a reasonable range. However, their estimated values for
(and thus r) are rather high: the annualized gross interest rates range from 1.4 to 2.2, or 40% and 120% annually. In light
of Theorem 1, this is not surprising: their estimated replacement ratios require that be relatively far from 1 in order to
avoid negative wages since those have zero likelihood in the model.22

5. Conclusion

In this paper I have characterized the mean-min ratio, which is a measure of the wage dispersion introduced by
Hornstein et al. (2011), for the model of Cahuc et al. (2006). I found that the most important parameter that governs
the mean-min ratio is , the bargaining power of workers: there is a threshold 1/2 above which the model essentially
delivers the same mean-min ratio as the canonical wage ladder model of Burdett (1978), while for  the mean-min
ratio is increasing in . In the extreme case of = 0 (Postel-Vinay and Robin, 2002b) we can even obtain negative wages,
which lead to an innite (or nonsensical) mean-min ratio. However, negative wages do not arise for small but positive
values of , and thus they should not affect the empirical performance of the general model in practice.
Although the mean-min ratio is not independent of distributions in the model, their inuence is very small in practice,
and it is possible to show that the mean-min ratio is invariant to scale transformations of the distributions (e.g. shape-
preserving changes in the variance), and we can also establish theoretical bounds in some cases. Thus the paper extends
the applicability of the mean-min ratio to yet another model in the spirit of Hornstein et al. (2011), who advocate the use
of this measure as a valuable tool in interpreting results from structural estimation.
Hornstein et al. (2011) also note that there is a tension between the low value of market time required to match the
cross-sectional wage dispersion and the high value of non-market time required to match time-series properties of labor
market dynamics (Shimer, 2005; Hornstein et al., 2005; Hagedorn and Manovskii, 2008; Costain and Reiter, 2008). The CPVR
model discussed in this paper does allow for a high (and thus a high value of non-market time), but it remains to be
examined whether it can help resolve the unemployment volatility puzzle.

Supplementary material

The online version of this article contains additional supplementary material.

Please visit http://dx.doi.org/10.1016/j.red.2013.02.002.

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22
PVR also write a version of the model with CRRA utility which averts negative wages by construction, but their model rules out saving and borrowing
in this case.
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