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Income risk and consumption inequality: a simulation study

Author

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  • Richard Blundell

    (Institute for Fiscal Studies and University College London)

  • Hamish Low

    (Institute for Fiscal Studies and University of Oxford & Nuffield College)

  • Ian Preston

    (Institute for Fiscal Studies and University College London)

Abstract

This paper assesses the accuracy of decomposing income risk into permanent and transitory components using income and consumption data. We develop a specific approximation to the optimal consumption growth rule and use Monte Carlo evidence to show that this approximation can provide a robust method for decomposing income risk. The availability of asset data enables the use of a more accurate approximation allowing for partial self-insurance against permanent shocks. We show that the use of data on median asset holdings corrects much of the error in the simple approximation which assumes no self-insurance against permanent shocks.

Suggested Citation

  • Richard Blundell & Hamish Low & Ian Preston, 2004. "Income risk and consumption inequality: a simulation study," IFS Working Papers W04/26, Institute for Fiscal Studies.
    • Handle: RePEc:ifs:ifsewp:04/26
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    File URL: http://www.ifs.org.uk/wps/wp0426.pdf
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    References listed on IDEAS

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    13. 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. Richard Blundell & Ben Etheridge, 2010. "Consumption, Income and Earnings Inequality in Britain," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 76-102, January.
    2. Cai, Shu & Park, Albert, 2016. "Permanent income and subjective well-being," Journal of Economic Behavior & Organization, Elsevier, vol. 130(C), pages 298-319.
    3. Theloudis, Alexandros, 2011. "From income and consumption inequality to economic welfare inequality: the role of labor supply," MPRA Paper 37517, University Library of Munich, Germany.

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    More about this item

    Keywords

    income risk; inequality; approximation methods; con-;
    All these keywords.

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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