Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework

94 Pages Posted: 28 Oct 2016

See all articles by Manuel Arellano

Manuel Arellano

CEMFI

Richard W. Blundell

UCL; Centre for Economic Policy Research (CEPR)

Stéphane Bonhomme

University of Chicago

Multiple version iconThere are 2 versions of this paper

Date Written: September 30, 2016

Abstract

We develop a new quantile-based panel data framework to study the nature of income persistence and the transmission of income shocks to consumption. Log-earnings are the sum of a general Markovian persistent component and a transitory innovation. The persistence of past shocks to earnings is allowed to vary according to the size and sign of the current shock. Consumption is modeled as an age-dependent nonlinear function of assets, unobservable tastes and the two earnings components. We establish the nonparametric identification of the nonlinear earnings process and of the consumption policy rule. Exploiting the enhanced consumption and asset data in recent waves of the Panel Study of Income Dynamics, we find that the earnings process features nonlinear persistence and conditional skewness. We confirm these results using population register data from Norway. We then show that the impact of earnings shocks varies substantially across earnings histories, and that this nonlinearity drives heterogeneous consumption responses. The framework provides new empirical measures of partial insurance in which the transmission of income shocks to consumption varies systematically with assets, the level of the shock and the history of past shocks.

Keywords: Earnings Dynamics, Consumption, Partial Insurance, Panel Data, Quantile Regression, Latent Variables

JEL Classification: C23, D31, D91

Suggested Citation

Arellano, Manuel and Blundell, Richard W. and Bonhomme, Stéphane, Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework (September 30, 2016). Becker Friedman Institute for Research in Economics Working Paper No. 2016-25, Available at SSRN: https://ssrn.com/abstract=2860277

Manuel Arellano (Contact Author)

CEMFI ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Richard W. Blundell

UCL ( email )

Department of Economics
Gower Street
London, WC1E 6BT
United Kingdom
+44 20 7504 5863 (Phone)
+44 20 7916 2773 (Fax)

HOME PAGE: http://www.ucl.ac.uk/~uctp39a/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Stéphane Bonhomme

University of Chicago

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
86
Abstract Views
821
Rank
337,971
PlumX Metrics