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Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework

Arellano, M; Blundell, R; Bonhomme, S; (2017) Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework. Econometrica , 85 (3) pp. 693-734. 10.3982/ECTA13795. Green open access

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Abstract

We develop a new quantile‐based panel data framework to study the nature of income persistence and the transmission of income shocks to consumption. Log‐earnings are the sum of a general Markovian persistent component and a transitory innovation. The persistence of past shocks to earnings is allowed to vary according to the size and sign of the current shock. Consumption is modeled as an age‐dependent nonlinear function of assets, unobservable tastes, and the two earnings components. We establish the nonparametric identification of the nonlinear earnings process and of the consumption policy rule. Exploiting the enhanced consumption and asset data in recent waves of the Panel Study of Income Dynamics, we find that the earnings process features nonlinear persistence and conditional skewness. We confirm these results using population register data from Norway. We then show that the impact of earnings shocks varies substantially across earnings histories, and that this nonlinearity drives heterogeneous consumption responses. The framework provides new empirical measures of partial insurance in which the transmission of income shocks to consumption varies systematically with assets, the level of the shock, and the history of past shocks.

Type: Article
Title: Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework
Open access status: An open access version is available from UCL Discovery
DOI: 10.3982/ECTA13795
Publisher version: http://dx.doi.org/10.3982/ECTA13795
Language: English
Additional information: This version is the version of record. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: Earnings dynamics, consumption, nonlinear persistence, partial insurance, panel data, quantile regression, latent variables
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/1560508
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