Modeling life-cycle earnings risk with positive and negative shocks

Abstract

We estimate explicit age-varying distributions of idiosyncratic persistent and transitory earnings shocks over workers' life-cycles using a German administrative data set. Large positive shocks, both transitory and persistent, are characteristic for the first eight years of the working life. After the age of 50, large negative shocks become a major source of earnings risk. Between the ages of 30 and 50, most shocks are small and transitory. Large persistent positive shocks that occur early in the working life help to rationalize large wealth and consumption shares of the top one percent in an incomplete markets model.