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An Empirical Investigation of Labor Income Processes

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Fatih Guvenen

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Abstract

In this paper we reassess the evidence on labor income risk. There are two leading views on the nature of the income process in the current literature. The first view, which we call the "Restricted Income Profiles" (RIP) process, holds that individuals are subject to large and very persistent shocks, while facing similar life-cycle income profiles. The alternative view, which we call the "Heterogeneous Income Profiles" (HIP) process, holds that individuals are subject to income shocks with modest persistence, while facing individual-specific income profiles.We first show that ignoring profile heterogeneity, when in fact it is present, introduces an upward bias into the estimates of persistence. Second, we estimate a parsimonious parameterization of the HIP process that is suitable for calibrating economic models. The estimated persistence is about 0.8 in the HIP process compared to about 0.99 in the RIP process. Moreover, the heterogeneity in income profiles is estimated to be substantial, explaining between 56 to 75 percent of income inequality at age 55. We also find that profile heterogeneity is substantially larger among higher educated individuals. Third, we discuss the source of identification -- in other words, the aspects of labor income data that allow one to distinguish between the HIP and RIP processes. Finally, we show that the main evidence against profile heterogeneity in the existing literature -- that the autocorrelations of income changes are small and negative -- is also replicated by the HIP process, suggesting that this evidence may have been misinterpreted.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13394.

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Date of creation: Sep 2007
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Handle: RePEc:nbr:nberwo:13394

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Find related papers by JEL classification:
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Fatih Guvenen & Burhanettin Kuruscu, 2006. "Ben-Porath meets skill-biased technical change: a theoretical analysis of rising inequality," Discussion Paper / Institute for Empirical Macroeconomics 144, Federal Reserve Bank of Minneapolis. [Downloadable!]
  2. Stéphane Bonhomme & Jean-Marc Robin, 2008. "Assessing the equalizing force of mobility using short panels: France 1990-2000," CeMMAP working papers CWP02/08, Centre for Microdata Methods and Practice, Institute for Fiscal Studies. [Downloadable!]
    Other versions:
  3. Christiane Clemens & Maik Heinemann, 2008. "On Entrepreneurial Risk–Taking and the Macroeconomic Effects of Financial Constraints," Working Paper Series in Economics 103, University of Lüneburg, Institute of Economics. [Downloadable!]
  4. Fatih Guvenen, 2005. "Learning Your Earning: Are Labor Income Shocks Really Very Persistent?," Macroeconomics 0507004, EconWPA. [Downloadable!]
    Other versions:
  5. Fatih Guvenen & Burhanettin Kuruscu, 2007. "Understanding the Evolution of the U.S. Wage Distribution: A Theoretical Analysis," NBER Working Papers 13096, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Pedro Albarrán & Raquel Carrasco & Maite Martínez-Granado, 2007. "Inequality for Wage Earners and Self-Employed: Evidence from Panel Data," Banco de España Working Papers 0734, Banco de España. [Downloadable!]
    Other versions:
  7. Manuel Arellano & Stéphane Bonhomme, 2009. "Identifying distributional characteristics in random coefficients panel data models," CeMMAP working papers CWP22/09, Centre for Microdata Methods and Practice, Institute for Fiscal Studies. [Downloadable!]
  8. Mark Aguiar & Erik Hurst, 2008. "Deconstructing Lifecycle Expenditure," Working Papers wp173, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
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  9. Low, Hamish & Meghir, Costas & Pistaferri, Luigi, 2008. "Wage Risk and Employment Risk over the Life Cycle," IZA Discussion Papers 3700, Institute for the Study of Labor (IZA). [Downloadable!]
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  10. Peter C.B. Phillips & Donggyu Sul, 2007. "Transition Modeling and Econometric Convergence Tests," Cowles Foundation Discussion Papers 1595, Cowles Foundation, Yale University. [Downloadable!]
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  11. Giorgio E. Primiceri & Thijs van Rens, 2006. "Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality," Economics Working Papers 945, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008. [Downloadable!]
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  12. Robert Moffitt & Peter Gottschalk, 2008. "Trends in the Transitory Variance of Male Earnings in the U.S., 1970-2004," Boston College Working Papers in Economics 697, Boston College Department of Economics. [Downloadable!]
  13. Stéphane Bonhomme & Jean-Marc Robin, 2008. "Generalized nonparametric deconvolution with an application to earnings dynamics," CeMMAP working papers CWP03/08, Centre for Microdata Methods and Practice, Institute for Fiscal Studies. [Downloadable!]
  14. Fatih Guvenen & Burhanettin Kuruscu, 2007. "A Quantitative Analysis of the Evolution of the U.S. Wage Distribution: 1970-2000," NBER Working Papers 13095, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Laura Veldkamp & Chris Edmond, 2006. "Income Dispersion, Asymmetric Information and Fluctuations in Market Efficiency," Working Papers 06-13, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
    Other versions:
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