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Changes in the Distribution of Income Volatility

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  • Shane T. Jensen
  • Stephen H. Shore
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    Abstract

    Recent research has documented a significant rise in the volatility (e.g., expected squared change) of individual incomes in the U.S. since the 1970s. Existing measures of this trend abstract from individual heterogeneity, effectively estimating an increase in average volatility. We decompose this increase in average volatility and find that it is far from representative of the experience of most people: there has been no systematic rise in volatility for the vast majority of individuals. The rise in average volatility has been driven almost entirely by a sharp rise in the income volatility of those expected to have the most volatile incomes, identified ex-ante by large income changes in the past. We document that the self-employed and those who self-identify as risk-tolerant are much more likely to have such volatile incomes; these groups have experienced much larger increases in income volatility than the population at large. These results color the policy implications one might draw from the rise in average volatility. While the basic results are apparent from PSID summary statistics, providing a complete characterization of the dynamics of the volatility distribution is a methodological challenge. We resolve these difficulties with a Markovian hierarchical Dirichlet process that builds on work from the non-parametric Bayesian statistics literature.

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    File URL: http://arxiv.org/pdf/0808.1090
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 0808.1090.

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    Date of creation: Aug 2008
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    Handle: RePEc:arx:papers:0808.1090

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    Web page: http://arxiv.org/

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    References

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    1. John F. Geweke & Michael P. Keane, 1997. "An empirical analysis of income dynamics among men in the PSID: 1968-1989," Staff Report 233, Federal Reserve Bank of Minneapolis.
    2. Costas Meghir & Luigi Pistaferri, 2001. "Income variance dynamics and heterogenity," IFS Working Papers W01/07, Institute for Fiscal Studies.
    3. Christopher D. Carroll & Andrew A. Samwick, 1995. "The Nature of Precautionary Wealth," NBER Working Papers 5193, National Bureau of Economic Research, Inc.
    4. Susan Dynarski & Jonathan Gruber, 1997. "Can Families Smooth Variable Earnings?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(1), pages 229-303.
    5. Haider, Steven J, 2001. "Earnings Instability and Earnings Inequality of Males in the United States: 1967-1991," Journal of Labor Economics, University of Chicago Press, vol. 19(4), pages 799-836, October.
    6. Shin, Donggyun & Solon, Gary, 2011. "Trends in men's earnings volatility: What does the Panel Study of Income Dynamics show?," Journal of Public Economics, Elsevier, vol. 95(7), pages 973-982.
    7. Robert A. Moffitt & Peter Gottschalk, 2002. "Trends in the Transitory Variance of Earnings in the United States," Economic Journal, Royal Economic Society, vol. 112(478), pages C68-C73, March.
    8. Comin, Diego & Groshen, Erica L. & Rabin, Bess, 2009. "Turbulent firms, turbulent wages?," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 109-133, January.
    9. John M. Abowd & David Card, 1986. "On the Covariance Structure of Earnings and Hours Changes," NBER Working Papers 1832, National Bureau of Economic Research, Inc.
    10. Mary C. Daly & Greg J. Duncan, 1997. "Earnings mobility and instability, 1969-1995," Working Papers in Applied Economic Theory 97-06, Federal Reserve Bank of San Francisco.
    11. Richard Blundell & Luigi Pistaferri & Ian Preston, 2008. "Consumption Inequality and Partial Insurance," American Economic Review, American Economic Association, vol. 98(5), pages 1887-1921, December.
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    Cited by:
    1. Betsey Stevenson & Justin Wolfers, 2008. "Happiness Inequality in the United States," NBER Working Papers 14220, National Bureau of Economic Research, Inc.
    2. Olga Gorbachev & Keshav Dogra, 2009. "Evolution of Consumption Volatility for the Liquidity Constrained Households over 1983 to 2004," ESE Discussion Papers 193, Edinburgh School of Economics, University of Edinburgh.
    3. Julien Champagne & André Kurmann, 2010. "The Great Increase in Relative Volatility of Real Wages in the United States," Cahiers de recherche 1010, CIRPEE.
    4. Laura Hospido, 2007. "Modelling heterogeneity and dynamics in the volatility of individual wages," Banco de España Working Papers 0738, Banco de España.
    5. Johannes Martin, 2013. "The Impact on Earnings when Entering Self-Employment: Evidence for Germany," SOEPpapers on Multidisciplinary Panel Data Research 537, DIW Berlin, The German Socio-Economic Panel (SOEP).
    6. Whalley, Alexander, 2011. "Education and labor market risk: Understanding the role of data cleaning," Economics of Education Review, Elsevier, vol. 30(3), pages 528-545, June.
    7. Claudia M. Buch, 2008. "The Great Risk Shift? Income Volatility in an International Perspective," CESifo Working Paper Series 2465, CESifo Group Munich.

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