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A Parsimonious Income Process for Business Cycle Analysis

Alisdair McKay () and Fatih Guvenen ()

No 1488, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper, we estimate a parsimonious income process that is consistent with several key features of how income risk varies over the business cycle. In particular, the estimated process generates year-to-year income changes that (i) have flat and acyclical variance, (ii) have volatile and procylical skewness, (iii) have very high excess kurtosis, and (iv) imply a moderate rise in cross-sectional inequality over the life cycle consistent with the US data. Furthermore, and importantly, the process also captures the predictable nature of business cycle income risk: income changes during a business cycle episode is partly predicted by income levels before that episode. The estimated process features a mixture of normals as well as a factor structure, both of which are driven by a latent process capturing the business cycle.

Date: 2016
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More papers in 2016 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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