Consumption and risk sharing over the life cycle

Abstract

A striking feature of U.S. data on income and consumption is that inequality increases with age. This paper asks if individual-specific earnings risk can provide a coherent explanation. We find that it can. We construct an overlapping generations general equilibrium model in which households face uninsurable earnings shocks over the course of their lifetimes. Earnings inequality is exogenous and is calibrated to match data from the U.S. Panel Study on Income Dynamics. Consumption inequality is endogenous and matches well data from the U.S. Consumer Expenditure Survey. The total risk households face is decomposed into that realized before entering the labor market and that realized throughout the working years. In welfare terms, the latter is found to be more important than the former. JEL Classification Codes: E21, D31.Keywords: Risk sharing, buffer-stock savings, consumption inequality * In addition to numerous participants at seminars and conferences, we thank Dave Backus, Rick Green, Burton Hollifield, Dean Hyslop, Mark Huggett, Bob Miller, Christina Paxson, Ed Prescott, B. Ravikumar, Víctor Ríos-Rull, Tom Sargent, Nick Souleles, Kenneth Wolpin, Stan Zin, and an anonymous referee for helpful comments and suggestions. We have benefited from the support of NSF grant SES-9987602 and the Rodney White Center at Wharton.

Optimal pensions in aging economies

“…In particular, the two-state Markov chain is calibrated so that the annual persistence amounts to 0.98 with an implied conditional variance of 8%. Accordingly, {η 1 , η 2 } = {0.727, 1.273} and Our modeling of individual productivity is in accordance with the large-scale OLG models of Storesletten, Telmer, and Yaron (2004), Conesa and Krueger (1999), and Krueger and Ludwig (2007). We acknowledge that our specification of the individual productivity process and, hence, the labor earnings is rather parsimonious and a simplification with respect to recent empirical evidence.…”

“…The age-efficiency profile {̄} 45 =1 is taken from Hansen (1993), interpolated to in-between years and normalized to one. The set of the equally distributed productivity types{ϵ 1 , ϵ 2 } = {0.57, 1.43} is taken from Storesletten, Telmer, and Yaron (2004). Our choice of the stochastic individual productivity component, η ∈ {η 1 , η 2 }, is also motivated by Storesletten, Telmer, and Yaron (2004).…”

“…The set of the equally distributed productivity types{ϵ 1 , ϵ 2 } = {0.57, 1.43} is taken from Storesletten, Telmer, and Yaron (2004). Our choice of the stochastic individual productivity component, η ∈ {η 1 , η 2 }, is also motivated by Storesletten, Telmer, and Yaron (2004). In particular, the two-state Markov chain is calibrated so that the annual persistence amounts to 0.98 with an implied conditional variance of 8%.…”

A note on the accuracy of Markov-chain approximations to highly persistent AR(1) processes

“…The …rst speci…cation follows Aiyagari (1994) and sets = 0:60 and 2 " = 0:013, while the second follows Hubbard et al (1995, HSZ) and sets = 0:95 and 2 " = 0:030. The …nal speci…cation, suggested by Storesletten et al (2000), is even more persistent and sets = 0:98 and 2 " = 0:020. In addition to examining these processes, I also examine the methods'accuracy for a broader set of autocorrelations.…”

Price Search, Consumption Inequality and Expenditure Inequality over the Life Cycle

“…Among many other studies in the quantitative life-cycle literature, this paper is closely related to Guvenen (2007), Storesletten et al (2004), and Karahan and Ozkan (2010). Those papers study the role of income processes on the age-inequality profile of consumption.…”