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A Parsimonious Model of Idiosyncratic Income

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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.

Suggested Citation

  • Edmund Crawley & Martin Holm & Håkon Tretvoll, 2022. "A Parsimonious Model of Idiosyncratic Income," Finance and Economics Discussion Series 2022-026, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2022-26
    DOI: 10.17016/FEDS.2022.026
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    Cited by:

    1. Tao Wang, 2023. "Perceived versus Calibrated Income Risks in Heterogeneous-Agent Consumption Models," Staff Working Papers 23-59, Bank of Canada.

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    More about this item

    Keywords

    Income uncertainty; Inequality; Household finance;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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