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This paper assesses the accuracy of decomposing income risk into permanent and transitory components using income and consumption data. We develop a specific approximation to the optimal consumption growth rule and use Monte Carlo evidence to show that this approximation can provide a robust method for decomposing income risk. The availability of asset data enables the use of a more accurate approximation allowing for partial self-insurance against permanent shocks. We show that the use of data on median asset holdings corrects much of the error in the simple approximation which assumes no self-insurance against permanent shocks.
Authors
CPP Co-Director
Richard is Co-Director of the Centre for the Microeconomic Analysis of Public Policy (CPP) and Senior Research Fellow at IFS.
Research Fellow University of Oxford
Hamish is the James Meade Professor of Economics at the University of Oxford, a Professorial Fellow of Nuffield College and a Research Fellow at IFS.
Research Fellow University College London
Ian is a Research Fellow of the IFS and a Professor of Economics at UCL. He joined UCL in 1991 and has been attached to the IFS since 1990.
Working Paper details
- DOI
- 10.1920/wp.ifs.2004.0426
- Publisher
- IFS
Suggested citation
R, Blundell and H, Low and I, Preston. (2004). Income risk and consumption inequality: a simulation study. London: IFS. Available at: https://ifs.org.uk/publications/income-risk-and-consumption-inequality-simulation-study (accessed: 26 April 2024).
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