### Quantitative Economics, Volume 3, Issue 2 (July 2012)

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

*Dmytro Hryshko*

#### Abstract

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.

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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