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A Parsimonious Income Process for Business Cycle Analysis

Author

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  • Alisdair McKay

    (Boston University)

  • Fatih Guvenen

    (University of Minnesota)

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.

Suggested Citation

  • Alisdair McKay & Fatih Guvenen, 2016. "A Parsimonious Income Process for Business Cycle Analysis," 2016 Meeting Papers 1488, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1488
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    Cited by:

    1. Alisdair McKay & Ricardo Reis, 2021. "Optimal Automatic Stabilizers [Consumption versus Expenditure]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(5), pages 2375-2406.

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