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Inequality over the business cycle: Estimating income risk using micro-data on consumption

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  • Giorgio Primiceri
  • Thijs van Rens

Abstract

We use CEX repeated cross-section data on consumption and income, to evaluate the nature of increased income inequality in the 1980s and 90s. We decompose unexpected changes in family income into transitory and permanent, and idiosyncratic and aggregate components, and estimate the contribution of each component to total inequality. The model we use is a linearized incomplete markets model, enriched to incorporate risk-sharing while maintaining tractability. Our estimates suggest that taking risk sharing into account is important for the model fit; that the increase in inequality in the 1980s was mainly permanent; and that inequality is driven almost entirely by idiosyncratic income risk. In addition we find no evidence for cyclical behavior of consumption risk, casting doubt on Constantinides and Duffie’s (1995) explanation for the equity premium puzzle.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 943.

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Date of creation: Jul 2002
Date of revision: Oct 2004
Handle: RePEc:upf:upfgen:943

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Web page: http://www.econ.upf.edu/

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Keywords: Consumption; inequality; risk; incomplete markets; business cycle;

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Citations

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Cited by:
  1. Primiceri, Giorgio E. & van Rens, Thijs, 2009. "Heterogeneous life-cycle profiles, income risk and consumption inequality," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(1), pages 20-39, January.
  2. Heathcote, Jonathan & Storesletten, Kjetil & Violante, Giovanni L, 2004. "The Cross-Sectional Implications of Rising Wage Inequality in the United States," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4296, C.E.P.R. Discussion Papers.
  3. Pozzi, Lorenzo, 2010. "Idiosyncratic labour income risk and aggregate consumption: An unobserved component approach," Journal of Macroeconomics, Elsevier, Elsevier, vol. 32(1), pages 169-184, March.
  4. Walentin, Karl, 2007. "Earnings Inequality and the Equity Premium," Working Paper Series 215, Sveriges Riksbank (Central Bank of Sweden).
  5. Lorenzo Pozzi, 2007. "Idiosyncratic Labour Income Risk and Aggregate Consumption: an Unobserved Component Approach," Tinbergen Institute Discussion Papers 07-069/2, Tinbergen Institute.
  6. Lorenzo Pozzi, 2007. "Idiosyncratic Labour Income Risk and Aggregate Consumption: an Unobserved Component Approach," Tinbergen Institute Discussion Papers 07-069/2, Tinbergen Institute.

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