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Inequality over the Business Cycle: Estimating Income Risk using Micro-Data on Consumption

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  • Giorgio Primiceri

    (Princeton University)

  • Thijs van Rens

    (Princeton University)

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 EconWPA in its series Macroeconomics with number 0212003.

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Length: 51 pages
Date of creation: 10 Dec 2002
Date of revision:
Handle: RePEc:wpa:wuwpma:0212003

Note: Type of Document - Adobe pdf (composed in SWP); prepared on IBM PC; to print on PostScript; pages: 51 ; figures: included. An updated version of this paper may be available at:
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Keywords: consumption inequality risk incomplete markets business cycle;

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References

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  25. Cogley, Timothy, 2002. "Idiosyncratic risk and the equity premium: evidence from the consumer expenditure survey," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 309-334, March.
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Citations

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