Econometrica: Jan 2004, Volume 72, Issue 1

Income Variance Dynamics and Heterogeneity

https://doi.org/10.1111/j.1468-0262.2004.00476.x
p. 1-32

Costas Meghir, Luigi Pistaferri

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 is 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 1967–1992 Panel Study of Income Dynamics. We find strong evidence of sizeable ARCH effects as well as evidence of unobserved heterogeneity in the variances.

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Supplemental Material

Supplement to ?Communication and Equilibrium in Discontinuous Games of Incomplete Information?

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Supplementary Material for "Income Variance Dynamics and Heterogeneity"

This zip file contains data and programs for the paper. The file results.do contains most of the explanations. The file that is called vit4.dta in "results.do" is the data file arch.dta supplied here. (You need gauss, the arellano-bond dpd and stata to run these files).

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