A Parsimonious Model of Idiosyncratic Income

Edmund Crawley, Martin Holm and Håkon Tretvoll

No 2022-026, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The standard model of permanent and transitory income is known to be misspecified. Estimates of income volatility in the model differ depending on the type of data moments used—levels or differences—and how these moments are weighted in the estimation. We propose two changes to the standard model. First, we account for the time-aggregated nature of observed income data. Second, we allow transitory shocks to persist for varying lengths of time. With only one additional parameter, our proposed model consistently recover the parameters of the income process irrespective of the estimation method. To the extent that researchers employ the standard model, we advise special caution with the use of first-difference moments.

Keywords: Income uncertainty; Inequality; Household finance (search for similar items in EconPapers)
JEL-codes: E21 E24 J30 (search for similar items in EconPapers)
Pages: 50 p.
Date: 2022-05-12
New Economics Papers: this item is included in nep-ecm, nep-lma and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2022-26

DOI: 10.17016/FEDS.2022.026

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