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Income risk and consumption inequality: a simulation study

  • Richard Blundell

    ()

    (Institute for Fiscal Studies and University College London)

  • Hamish Low

    ()

    (Institute for Fiscal Studies and Trinity College, Cambridge)

  • Ian Preston

    ()

    (Institute for Fiscal Studies and University College London)

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.

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File URL: http://www.ifs.org.uk/wps/wp0426.pdf
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Paper provided by Institute for Fiscal Studies in its series IFS Working Papers with number W04/26.

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Length: 27 pp.
Date of creation: Oct 2004
Date of revision:
Handle: RePEc:ifs:ifsewp:04/26
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  1. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
  2. Orazio Attanasio & Steven J. Davis, 1994. "Relative Wage Movements and the Distribution of Consumption," NBER Working Papers 4771, National Bureau of Economic Research, Inc.
  3. Krueger, Dirk & Perri, Fabrizio, 2002. "Does Income Inequality Lead to Consumption Inequality?," CEPR Discussion Papers 3583, C.E.P.R. Discussion Papers.
  4. Robert A. Moffitt & Peter Gottschalk, 2002. "Trends in the Transitory Variance of Earnings in the United States," Economic Journal, Royal Economic Society, vol. 112(478), pages C68-C73, March.
  5. Costas Meghir & Luigi Pistaferri, 2001. "Income variance dynamics and heterogenity," IFS Working Papers W01/07, Institute for Fiscal Studies.
  6. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-56, October.
  7. Abowd, John M & Card, David, 1989. "On the Covariance Structure of Earnings and Hours Changes," Econometrica, Econometric Society, vol. 57(2), pages 411-45, March.
  8. 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.
  9. Deaton, A. & Paxson, C., 1993. "Intertemporal Choice and Inequality," Papers 168, Princeton, Woodrow Wilson School - Development Studies.
  10. Richard V. Burkhauser & John G. Poupore, 1997. "A Cross-National Comparison Of Permanent Inequality In The United States And Germany," The Review of Economics and Statistics, MIT Press, vol. 79(1), pages 10-17, February.
  11. Christopher D. Carroll, 1996. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," NBER Working Papers 5788, National Bureau of Economic Research, Inc.
  12. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-57, December.
  13. Sumru Altug & Robert Miller, . "Household Choices in Equilibrium," University of Chicago - Population Research Center 87-8, Chicago - Population Research Center.
  14. Richard Blundell & Ian Preston, 1997. "Consumption, inequality and income uncertainty," IFS Working Papers W97/15, Institute for Fiscal Studies.
  15. Moshe Buchinsky & Jennifer Hunt, 1996. "Wage Mobility in the United States," NBER Working Papers 5455, National Bureau of Economic Research, Inc.
  16. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
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