On the Persistence of Income Shocks over the Life Cycle: Evidence, Theory, and Implications,Second Version
Fatih Karahan () and
Serdar Ozkan ()
PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania
How does the persistence of earnings change over the life cycle? Do workers at different ages face the same variance of idiosyncratic shocks? This paper proposes a novel specification for residual earnings that allows for an age profile in the persistence and variance of labor income shocks. We show that the statistical model is identified and estimate it using PSID data. We find that shocks to earnings are only moderately persistent (around 0:75) for young workers. Persistence rises with age up to unity until midway in life. The variance of persistent shocks exhibits a U-shaped profile over the life cycle (with a minimum of 0:01 and a maximum of 0:05). These results suggest that the standard specification in the literature (with constant persistence and variances) cannot capture the earnings dynamics of young workers. We also argue that a calibrated job turnover model can account for these non-at profiles. The key idea is that workers sort into better jobs and settle down as they age; in turn, magnitudes of wage growth rates decline, thereby decreasing variance of shocks. Furthermore the decline in job mobility results in higher persistence. Finally, we investigate the implications of age profiles for consumption-savings behavior. The welfare cost of idiosyncratic risk implied by the age-dependent income process is 34 percent lower compared with its age-invariant counterpart. This difference is mostly due to a higher degree of consumption insurance for young workers, for whom persistence is moderate. These results suggest that age profilles of persistence and variances should be taken into account when calibrating life-cycle models.
Keywords: Idiosyncratic income risk; Incomplete markets models; Earnings persistence; onsumption insurance (search for similar items in EconPapers)
JEL-codes: C33 D31 D91 E21 J31 (search for similar items in EconPapers)
Pages: 65 pages
Date: 2009-09-15, Revised 2011-09-02
References: Add references at CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:11-030
Access Statistics for this paper
More papers in PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania 133 South 36th Street, Philadelphia, PA 19104. Contact information at EDIRC.
Bibliographic data for series maintained by Administrator ().