Abstract : This paper examines heterogeneous income risk and its impact on consumption response. A novel framework is proposed where household-specific variances of persistent and transitory income shocks are considered. This study empirically investigates several key aspects of heterogeneous income risk using the Panel Study of Income Dynamics (PSID). First, the distribution of household-fixed income volatility exhibits right-skewness with a fat tail, challenging conventional income dynamics literature. Second, a considerable portion of the heterogeneity in income risk remains unexplained by observable characteristics, highlighting latent factors. Third, households experiencing more volatile transitory risk tend to exhibit less consumption response. I estimate an income process under the assumption of reliable parametric income shocks to capture the income volatility distribution and consumption response to heterogeneous income risk. Quantitatively, I use a standard life-cycle incomplete market model to demonstrate that the model's predictions align consistently with empirical estimates.
Subsistence Self-employment among the Old and Retirement in Frictional Labor Markets (with Kadidia Kamate)