EARNINGS DYNAMICS, SAVING AND ADJUSTMENT TO SHOCKS

University Of Michigan At Ann Arbor, Ann Arbor MI

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Abstract

Earnings dynamics and the adjustment of households to shocks to their earnings are fundamental ingredients to understanding many aspects of household behavior. Moreover, they are key determinants of how households will respond to changes in Social Security policy. This project will use unique elements of the Health and Retirement Survey to quantify the stochastic process for earnings and to study how households respond to shocks to their earnings. The project has two parts. The first will estimate earnings dynamics. The second will use these estimates of earnings dynamics to study saving, asset accumulation, and portfolio choice. First, this project will exploit the matching of the Social Security Administration's earnings histories and the HRS data in order to quantify the dynamics of individuals' earnings over their lives. It will focus on describing and interpreting the relative importance of permanent transitory movements in earnings, and thus characterize the relation between current income and permanent income. Second, the project will use the estimated earnings dynamics--together with data on wealth, saving and consumption, and portfolio choice--to analyze household saving and asset accumulation decisions. It will address several questions. How do households respond to unpredictable movements in earnings? How do households adjust their asset stock in anticipation of shocks to earnings? And how do portfolio allocations, e.g. between stocks and bonds, respond to earnings uncertainty.