Wealth and labor supply heterogeneity

•Ex-ante heterogeneity is studied in an incomplete markets model.•Model is estimated using data from NLSY79.•Model produces a realistic wealth and employment relationship.•It implies employment elasticities smaller than models without ex-ante heterogeneity.

This paper examines the importance of ex-ante heterogeneity for understanding the relationship between wealth and labor supply when markets are incomplete. An infinite horizon model is estimated where labor supply is indivisible and households are ex-ante heterogeneous in their labor disutility and market skills. The model replicates key features of the distribution of employment, wages, and wealth observed in the data. Importantly, it reverses the prediction that employment falls with wealth, a pervasive feature of models without ex-ante heterogeneity. A byproduct of the model's empirical performance is that it implies labor supply responses to unanticipated wage changes (e.g., Frisch elasticities) that are a half to two-thirds of those recovered from models with only ex-post heterogeneity.