Higher-Order Income Risk over the Business Cycle

86 Pages Posted: 27 Mar 2020 Last revised: 8 Sep 2020

See all articles by Christopher Busch

Christopher Busch

Autonomous University of Barcelona - MOVE (Markets, Organizations and Votes in Economics)

Alexander Ludwig

Leibniz Institute for Financial Research SAFE; University of Cologne - Faculty of Management, Economics and Social Sciences

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Date Written: March 24, 2020

Abstract

We extend the canonical income process with persistent and transitory risk to shock distributions with left-skewness and excess kurtosis, to which we refer as higher- order risk. We estimate our extended income process by GMM for household data from the United States. We find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. The existing tax and transfer system reduces dispersion and left-skewness of shocks. We then show that in a standard incomplete-markets life-cycle model, first, higher-order risk has sizable welfare implications, which depend crucially on risk attitudes of households; second, higher-order risk matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, higher-order risk has non-trivial implications for the degree of self-insurance against both transitory and persistent shocks.

Keywords: Labor Income Risk, Business Cycle, GMM Estimation, Skewness, Persistent and Transitory Income Shocks, Risk Attitudes, Life-Cycle Model

JEL Classification: D31, E24, E32, H31, J31

Suggested Citation

Busch, Christopher and Ludwig, Alexander, Higher-Order Income Risk over the Business Cycle (March 24, 2020). SAFE Working Paper No. 274, Available at SSRN: https://ssrn.com/abstract=3562359 or http://dx.doi.org/10.2139/ssrn.3562359

Christopher Busch

Autonomous University of Barcelona - MOVE (Markets, Organizations and Votes in Economics) ( email )

Campus de Bellaterra-UAB Edifici B (s/n)
EDIFICI B
Cerdanyola del Vallès
, Barcelona 08193
Spain

Alexander Ludwig (Contact Author)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

University of Cologne - Faculty of Management, Economics and Social Sciences ( email )

Albertus-Magnus-Platz
Cologne, D-50923
Germany

HOME PAGE: http://www.wiso.uni-koeln.de/cmr/alexludwig

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