Quantitative Economics: Jul, 2012, Volume 3, Issue 2

Labor income profiles are not heterogeneous: Evidence from income growth rates

Dmytro Hryshko

Idiosyncratic labor incomes are typically modeled either by stochastic processes
with heterogeneous income profiles (HIPs) or restricted income profiles (RIPs).
The HIP assumes that individual labor income grows deterministically at an unobserved
rate and contains a persistent but stationary component, while the RIP
assumes that income contains a random walk, a stationary component, and no
unobserved deterministic growth-rate component. I show that if idiosyncratic labor
income contains a persistent component, a deterministic household-specific
trend, and a random-walk component, then all of the components can be identified
in small unbalanced panels. Using data on idiosyncratic labor income growth
from the Panel Study of Income Dynamics, I find that the estimated variance of
deterministic income growth is zero, that is, the HIP model can be rejected. The
RIP model with a permanent component cannot be rejected. This result is important
for an appropriate choice of modeling the heterogeneity in individual incomes
and calibrating/estimating macromodels with incomplete insurance markets
and heterogeneous agents.
Keywords. Idiosyncratic income processes, heterogeneity, labor income risk.
JEL classification. J31, D91, E21.

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