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Decomposing changes in income risk using consumption data

Author

Listed:
  • Richard Blundell

    (Institute for Fiscal Studies and University College London)

  • Hamish Low

    (Institute for Fiscal Studies and University of Oxford & Nuffield College)

  • Ian Preston

    (Institute for Fiscal Studies and University College London)

Abstract

This paper concerns the decomposition of income risk into permanent and transitory components using repeated cross-section data on income and consumption. Our focus is on the detection of changes in the magnitudes of variances of permanent and transitory risks. A new approximation to the optimal consumption growth rule is developed. Evidence from a dynamic stochastic simulation is used to show that this approximation can provide a robust method for decomposing income risk in a nonstationary environment. We examine robustness to unobserved heterogeneity in consumption growth and to unobserved heterogeneity in income growth. We use this approach to investigate the growth in income inequality in the UK in the 1980s.

Suggested Citation

  • Richard Blundell & Hamish Low & Ian Preston, 2008. "Decomposing changes in income risk using consumption data," IFS Working Papers W08/13, Institute for Fiscal Studies.
  • Handle: RePEc:ifs:ifsewp:08/13
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    References listed on IDEAS

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    More about this item

    Keywords

    Income risk; inequality; approximation methods; consumption;
    All these keywords.

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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