Events at CERGE-EI

Christopher Busch, Ph.D.

Ludwig Maximilian University of Munich, Germany

Authors: Christopher Busch and Alex Ludwig

Abstract: We extend the canonical income process with persistent and transitory risk to cyclical shock distributions with left-skewness and excess kurtosis. We estimate our income process by GMM for US household data. Consistent with previous results, we find countercyclical variance and procyclical skewness of persistent shocks. All shock distributions are highly leptokurtic. We then show that in a standard incomplete-markets life-cycle model, first, the existence of this higher-order risk has non-trivial implications for self-insurance against shocks; second, it has sizable welfare implications, which depend on risk attitudes; third, it matters quantitatively for the welfare costs of cyclical idiosyncratic risk.