Scandinavian Working Papers in Economics

Working Paper Series, Center for Labor Studies,
Uppsala University, Department of Economics

No 2010:19: Does the Labor-Income Process Contain a Unit Root? Evidence from Individual-Specific Time Series

Magnus Gustavsson () and Pär Österholm ()
Additional contact information
Magnus Gustavsson: Uppsala Center for Labor Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden
Pär Österholm: National Institute of Economic Research, Postal: Box 3116, 103 62 Stockholm, Sweden

Abstract: Employing econometric methods for univariate time series, this paper investigates the empirical validity of assuming a unit root in individuals’ labor-income processes. Using a Swedish register-based longitudinal dataset which allows us to follow a cohort of workers from 1968 to 2005, we are able to obtain distributions of median unbiased estimates of localto- unity parameters. The results indicate that earnings for the representative worker are governed by a process where shocks to earnings have fairly high persistence but are both economically and statistically significantly different from having permanent effects; that is, the largest autoregressive root is less than unity. These results add to the studies that question the heavy use of unit-root processes for earnings in calibrations of life-cycle models.

Keywords: Idiosyncratic income risk; Unit-root model; Earnings dynamics; Local-to-unity parameter

JEL-codes: C22; C23; J31

26 pages, December 9, 2010

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