Earnings Dynamics under Firm Heterogeneity

We develop a permanent–transitory earnings process in which permanent shocks depend on a latent firm type and workers’ exposure to firm types is persistent. Persistence can substantially slow the finite-horizon attenuation of earnings skewness and excess kurtosis over the life cycle relative to an iid mixture benchmark. We estimate the model from matched employer-employee data, first grouping firms based on the distribution of residual earnings changes and then using worker transitions across groups to estimate persistence. Finnish data reveal heterogeneity in permanent-shock variances and persistent exposure to firm groups. Although skewness and excess kurtosis are not targeted in estimation, over ages 35–50 the extended model accounts for 49 percent of average empirical skewness and 39 percent of average excess kurtosis, compared with 4 percent and 3 percent under the iid benchmark. Quantitative exercises show that persistence increases the life-cycle cost of earnings risk and affects saving behavior.