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

  • Giorgio Primiceri
  • Thijs van Rens

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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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
Contact details of provider: Web page: http://www.econ.upf.edu/

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  12. Danny Quah, 1991. "The Relative Importance of Permanent and Transitory Components: Identi- fication and Some Theoretical Bounds," NBER Technical Working Papers 0106, National Bureau of Economic Research, Inc.
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  18. Dirk Kreuger & Fabrizio Perri, 2002. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory," Working Papers 02-15, New York University, Leonard N. Stern School of Business, Department of Economics.
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