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Improving Models of Income Dynamics Using Cross-Section-Information

Summary

Based on a relative entropy approach, this paper proposes a method to estimate or update transition matrices using just cross-sectional observations at two points in time. The method is then applied to explain the development of the US income distribution. Starting from three hypothesized transition matrices and a transition matrix estimated from the PSID data, we show how these matrices must be adjusted in the light of the cross-sectional information. Finally, we explore the consequences of these updated transition matrices for the future development of the US income distribution.

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Correspondence to Robert Aebi.

Additional information

We thank Richard Burkhauser and Amy Cutts for providing us the data. We also want to thank the seminar and conference participants at the Institute for Advanced Studies in Vienna, Stanford University, ESEM 1999 and 2001, as well as Robert E. Leu and Edward Lazear for comments and suggestions.

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Open Access This article is distributed under the terms of the Creative Commons Attribution 2.0 International License ( https://creativecommons.org/licenses/by/2.0 ), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

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Aebi, R., Neusser, K. & Steiner, P. Improving Models of Income Dynamics Using Cross-Section-Information. Swiss J Economics Statistics 144, 117–151 (2008). https://doi.org/10.1007/BF03399251

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Keywords

  • income distribution
  • income dynamics
  • relative entropy

JEL-Classification

  • D31
  • C51