Higher-Order Income Risk over the Business Cycle

83 Pages Posted: 18 May 2020

See all articles by Christopher Busch

Christopher Busch

Autonomous University of Barcelona - MOVE (Markets, Organizations and Votes in Economics); Barcelona Graduate School of Economics (Barcelona GSE)

Alexander Ludwig

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA); Goethe University Frankfurt

Multiple version iconThere are 3 versions of this paper

Date Written: 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 (2020). ZEW - Centre for European Economic Research Discussion Paper No. 20-022, Available at SSRN: https://ssrn.com/abstract=3601620 or http://dx.doi.org/10.2139/ssrn.3601620

Christopher Busch (Contact Author)

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

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Alexander Ludwig

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA) ( email )

Amalienstrasse 33
Munich, 80799
Germany

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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