Inferring Labor Income Risk and Partial Insurance from Economic Choices

By Fatih Guvenen, Anthony A. Smith. 2014

164 citations recorded by the source corpus.

This paper uses the information contained in the joint dynamics of individuals' labor earnings and consumption‐choice decisions to quantify both the amount of income risk that individuals face and the extent to which they have access to informal insurance against this risk. We accomplish this task by using indirect inference to estimate a structural consumption–savings model, in which individuals both learn about the nature of their income process and partly insure shocks via informal mechanisms. In this framework, we estimate (i) the degree of partial insurance, (ii) the extent of systematic differences in income growth rates, (iii) the precision with which individuals know their own income growth rates when they begin their working lives, (iv) the persistence of typical labor income shocks, (v) the tightness of borrowing constraints, and (vi) the amount of measurement error in the data. In implementing indirect inference, we find that an auxiliary model that approximates the true structural equations of the model (which are not estimable) works very well, with negligible small sample bias. The main substantive findings are that income shocks are moderately persistent, systematic differences in income growth rates are large, individuals have substantial amounts of information about their income growth rates, and about one‐half of income shocks are smoothed via partial insurance. Putting these findings together, the amount of uninsurable lifetime income risk that individuals perceive is substantially smaller than what is typically assumed in calibrated macroeconomic models with incomplete markets.

Subfields: Accounting, Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/5200e2db9ff947f6a4e42c139bef337f2c67b533

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Citations in the corpus

What Do Data on Millions of U.S. Workers Reveal about Life-Cycle Earnings Risk? (2015, unknown): “24Exceptions include Browning et al. (2010), Altonji et al. (2013), and Guvenen and Smith (2014).”
Mortgage Design in an Equilibrium Model of the Housing Market (2018, background): “This can be thought of as a social security benefit that conditions on terminal income rather than average lifetime income for computational tractability, as in Guvenen and Smith (2014).”
House Prices and Consumer Spending (2015, unknown): “Several recent papers such as Kaplan et al. (2015) and Stroebel and Vavra (2015) also arrive at similar numbers using new scanner spending data and additional identification strategies. Our paper is part of a large and growing literature studying the theoretical response of consumption to house pric”
Household Leverage and the Recession (2011, unknown): “As earlier, the household also faces a liquidity constraint limiting the consumption of an individual member to be below the amount of real balances the member holds: cit(s) ≤ xt(s), (24)”