Abstract

This paper shows that workers’ misperceptions of earnings risk lead to insufficient financial preparedness and amplify the transmission of income shocks. Using new survey data on subjective labor-market beliefs linked to administrative records on earnings, employment, and assets for about 20,000 Danish workers, we document that workers are, on average, well calibrated about mean earnings growth but systematically understate the variability of their earnings. Nearly half hold liquid assets worth less than two months of income, and about 40 percent exhibit \textit{belief overprecision}—they are overly certain about their future earnings and underestimate the true risk they face. These workers save less and, when surprised by income losses, cut spending sharply rather than drawing on assets. A calibrated life-cycle model shows that belief overprecision imposes substantial welfare costs and increases aggregate consumption volatility by weakening self-insurance. The results identify miscalibrated risk perceptions—not risk itself—as a hidden source of incomplete insurance and macroeconomic amplification.