Income Variance Dynamics and Heterogeneity

40 Pages Posted: 6 Dec 2002

See all articles by Costas Meghir

Costas Meghir

Yale University; Yale University - Cowles Foundation; Institute for Fiscal Studies (IFS); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Luigi Pistaferri

Centre for Economic Policy Research (CEPR); Stanford University

Date Written: November 2002

Abstract

Recent theoretical work has shown the importance of measuring microeconomic uncertainty for models of both general and partial equilibrium under imperfect insurance. In this Paper the assumption of i.i.d. income innovations used in previous empirical studies is removed and the focus of the analysis placed on models for the conditional variance of income shocks, which is related to the measure of risk emphasized by the theory. We first discriminate amongst various models of earnings determination that separate income shocks into idiosyncratic transitory and permanent components. We allow for education- and time-specific differences in the stochastic process for earnings and for measurement error. The conditional variance of the income shocks is modelled as a parsimonious ARCH process with both observable and unobserved heterogeneity. The empirical analysis is conducted on data drawn from the 1967-92 Panel Study of Income Dynamics. We find strong evidence of sizeable ARCH effects as well as evidence of unobserved heterogeneity in the variances.

Keywords: Microeconomic uncertainty, ARCH, earnings

JEL Classification: D80, J30

Suggested Citation

Meghir, Costas and Pistaferri, Luigi and Pistaferri, Luigi, Income Variance Dynamics and Heterogeneity (November 2002). Available at SSRN: https://ssrn.com/abstract=359580

Costas Meghir (Contact Author)

Yale University ( email )

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Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
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Institute for Fiscal Studies (IFS) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR)

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IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Luigi Pistaferri

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Stanford University ( email )

Stanford, CA 94305
United States

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