Higher-order income risk over the business cycle


Busch, Christopher ; Ludwig, Alexander


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URL: https://madoc.bib.uni-mannheim.de/55856
URN: urn:nbn:de:bsz:180-madoc-558562
Document Type: Working paper
Year of publication: 2020
The title of a journal, publication series: ZEW Discussion Papers
Volume: 20-022
Place of publication: Mannheim
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: D31 , E24 , E32 , H31 , J31,
Keywords (English): Labor income risk , business cycle , GMM estimation , skewness , persistent and transitory income shocks , risk attitudes , life-cycle model
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.

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Busch, Christopher ; Ludwig, Alexander (2020) Higher-order income risk over the business cycle. Open Access ZEW Discussion Papers Mannheim 20-022 [Working paper]
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