Reconciling Estimates of Earnings Processes in Growth Rates and Levels

Moira Daly, Dmytro Hryshko, Iourii Manovskii

Research output: Contribution to conferencePaperResearch

Abstract

The stochastic process for earnings is the key element of incomplete markets models in modern quantitative macroeconomics. It determines both the equilibrium distributions of endogenous outcomes and the design of optimal policies. Yet, there is no consensus in the literature on the relative magnitudes of the permanent and transitory innovations in earnings. When estimation is based on the earnings moments in levels, the variance of transitory shocks is found to be relatively high. When the moments in differences are used, the variance of the permanent component is relatively
high instead. We show theoretically that the difference can be induced by the fact that earnings at the start or at the end of earnings spells are lower and more volatile than the observations in the interior of earnings histories. Using large administrative datasets from Denmark and Germany, we show that this property of earnings spells quantitatively accounts for the full amount of discrepancy in the estimates. Using data from the Panel Study of Income Dynamics, we show that this property of earnings induces a substantial upward bias in the estimate of consumption insurance against permanent shocks.
Original languageEnglish
Publication date2015
Number of pages49
Publication statusPublished - 2015
EventFourth Conference on Household Finance and Consumption 2015 - ECB Main Building, Frankfurt am Main, Germany
Duration: 17 Dec 201518 Dec 2015
Conference number: 4
https://www.ecb.europa.eu/pub/conferences/html/20151217_4th_conference_hfcs.en.html

Conference

ConferenceFourth Conference on Household Finance and Consumption 2015
Number4
LocationECB Main Building
CountryGermany
CityFrankfurt am Main
Period17/12/201518/12/2015
Internet address

Cite this

Daly, M., Hryshko, D., & Manovskii, I. (2015). Reconciling Estimates of Earnings Processes in Growth Rates and Levels. Paper presented at Fourth Conference on Household Finance and Consumption 2015, Frankfurt am Main, Germany.
Daly, Moira ; Hryshko, Dmytro ; Manovskii, Iourii. / Reconciling Estimates of Earnings Processes in Growth Rates and Levels. Paper presented at Fourth Conference on Household Finance and Consumption 2015, Frankfurt am Main, Germany.49 p.
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Daly, M, Hryshko, D & Manovskii, I 2015, 'Reconciling Estimates of Earnings Processes in Growth Rates and Levels' Paper presented at, Frankfurt am Main, Germany, 17/12/2015 - 18/12/2015, .

Reconciling Estimates of Earnings Processes in Growth Rates and Levels. / Daly, Moira; Hryshko, Dmytro; Manovskii, Iourii.

2015. Paper presented at Fourth Conference on Household Finance and Consumption 2015, Frankfurt am Main, Germany.

Research output: Contribution to conferencePaperResearch

TY - CONF

T1 - Reconciling Estimates of Earnings Processes in Growth Rates and Levels

AU - Daly, Moira

AU - Hryshko, Dmytro

AU - Manovskii, Iourii

PY - 2015

Y1 - 2015

N2 - The stochastic process for earnings is the key element of incomplete markets models in modern quantitative macroeconomics. It determines both the equilibrium distributions of endogenous outcomes and the design of optimal policies. Yet, there is no consensus in the literature on the relative magnitudes of the permanent and transitory innovations in earnings. When estimation is based on the earnings moments in levels, the variance of transitory shocks is found to be relatively high. When the moments in differences are used, the variance of the permanent component is relativelyhigh instead. We show theoretically that the difference can be induced by the fact that earnings at the start or at the end of earnings spells are lower and more volatile than the observations in the interior of earnings histories. Using large administrative datasets from Denmark and Germany, we show that this property of earnings spells quantitatively accounts for the full amount of discrepancy in the estimates. Using data from the Panel Study of Income Dynamics, we show that this property of earnings induces a substantial upward bias in the estimate of consumption insurance against permanent shocks.

AB - The stochastic process for earnings is the key element of incomplete markets models in modern quantitative macroeconomics. It determines both the equilibrium distributions of endogenous outcomes and the design of optimal policies. Yet, there is no consensus in the literature on the relative magnitudes of the permanent and transitory innovations in earnings. When estimation is based on the earnings moments in levels, the variance of transitory shocks is found to be relatively high. When the moments in differences are used, the variance of the permanent component is relativelyhigh instead. We show theoretically that the difference can be induced by the fact that earnings at the start or at the end of earnings spells are lower and more volatile than the observations in the interior of earnings histories. Using large administrative datasets from Denmark and Germany, we show that this property of earnings spells quantitatively accounts for the full amount of discrepancy in the estimates. Using data from the Panel Study of Income Dynamics, we show that this property of earnings induces a substantial upward bias in the estimate of consumption insurance against permanent shocks.

M3 - Paper

ER -

Daly M, Hryshko D, Manovskii I. Reconciling Estimates of Earnings Processes in Growth Rates and Levels. 2015. Paper presented at Fourth Conference on Household Finance and Consumption 2015, Frankfurt am Main, Germany.