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Improving Models of Income Dynamics Using Cross-Section-Information


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

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