The prevalence of labor contracts with fixed duration seems surprising. Why is a fixed duration preferred to a stochastic duration that depends on the consumer price index? In this paper, the specification of the contract duration is determined endogeneously. The wage rate can be indexed to the consumer price index, but there is a loss since the indexation must be the same for different types of shocks. This loss increases with the variability of the contract duration. Since the loss due to the contracting cost depends on the expected discounted duration only, a fixed duration is chosen.
|Number of pages||12|
|Journal||The American Economic Review|
|State||Published - 1992|