Theoretical Framework — An Extended Search Model

Abstract

To model transitions from unemployment to self-employment theory provides in principle two guidelines. The first alternative is to model these transitions in the framework of dynamic occupational choice. However, the theoretical work provided by Lucas (1978) and Kihlstrom and Laffont (1979) only models the role of management capabilities, risk preferences and the initial capital endowment for the choice between self-employment and paid-employment, neglecting the state of unemployment. In principle, the state of unemployment could be incorporated in the models of occupational choice, but the focus of the analysis in this study is still the individual unemployment behaviour. The standard approach to model individual unemployment behaviour in empirical labour market economics is the use of hazard rate models (see Devine and Kiefer, 1991). The hazard of leaving unemployment can be interpreted as a reduced standard job-search model (see Steiner, 2001). Therefore, the second alternative, the job-search model, seems to be more appropriate to model transitions from unemployment to self-employment. However, the theory of occupational choice is not completely waived. As the standard search theory does not include the option of self-employment, the basic model is extended by some considerations derived by the theory of occupational choice.