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21-02-2019 | Issue 1/2020

Empirical Economics 1/2020

Testing functional forms of the lifetime income process in the presence of factor loadings

Journal:
Empirical Economics > Issue 1/2020
Author:
Yuri Ostrovsky
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The online version of this article (https://​doi.​org/​10.​1007/​s00181-019-01625-4) contains supplementary material, which is available to authorized users.

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Abstract

I show that a covariance-based test typically used to distinguish between lifetime income models known as Heterogeneous Income Profiles and Restricted Income Profiles will lead to erroneous conclusions in the presence of time-varying factor loadings on the permanent earnings component. The magnitude of a potential estimation bias associated with this test is examined using a Monte-Carlo simulation exercise.

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