The persistent-transitory representation for earnings processes

Mette Ejrnæs; Martin Browning

doi:10.3982/QE239

The persistent-transitory representation for earnings processes

7 Citations (Scopus)

Abstract

We consider the decomposition of shocks to a dynamic process into a persistent and a transitory component. Without additional assumptions (such as zero correlation) the decomposition of shocks into a persistent and transitory component is indeterminate. The assumption that is conventional in the earnings literature is that there is no correlation. The Beveridge-Nelson decomposition that is widely used in time series analysis assumes a perfect correlation. Without restrictions on the correlation, the persistent-transitory decomposition is only set-identified. For reasonable autoregressive moving average (ARMA) parameters the bounds for widely used objects of interest are very wide. We illustrate that these disquieting findings are of considerable practical importance, using a sample of male workers drawn from the Panel Study of Income Dynamics (PSID).

Original language	English
Journal	Quantitative Economics
Volume	5
Issue number	3
Pages (from-to)	555–581
Number of pages	27
ISSN	1759-7323
DOIs	https://doi.org/10.3982/QE239
Publication status	Published - 1 Nov 2014

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abstract = "We consider the decomposition of shocks to a dynamic process into a persistent and a transitory component. Without additional assumptions (such as zero correlation) the decomposition of shocks into a persistent and transitory component is indeterminate. The assumption that is conventional in the earnings literature is that there is no correlation. The Beveridge-Nelson decomposition that is widely used in time series analysis assumes a perfect correlation. Without restrictions on the correlation, the persistent-transitory decomposition is only set-identified. For reasonable autoregressive moving average (ARMA) parameters the bounds for widely used objects of interest are very wide. We illustrate that these disquieting findings are of considerable practical importance, using a sample of male workers drawn from the Panel Study of Income Dynamics (PSID).",

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N2 - We consider the decomposition of shocks to a dynamic process into a persistent and a transitory component. Without additional assumptions (such as zero correlation) the decomposition of shocks into a persistent and transitory component is indeterminate. The assumption that is conventional in the earnings literature is that there is no correlation. The Beveridge-Nelson decomposition that is widely used in time series analysis assumes a perfect correlation. Without restrictions on the correlation, the persistent-transitory decomposition is only set-identified. For reasonable autoregressive moving average (ARMA) parameters the bounds for widely used objects of interest are very wide. We illustrate that these disquieting findings are of considerable practical importance, using a sample of male workers drawn from the Panel Study of Income Dynamics (PSID).

AB - We consider the decomposition of shocks to a dynamic process into a persistent and a transitory component. Without additional assumptions (such as zero correlation) the decomposition of shocks into a persistent and transitory component is indeterminate. The assumption that is conventional in the earnings literature is that there is no correlation. The Beveridge-Nelson decomposition that is widely used in time series analysis assumes a perfect correlation. Without restrictions on the correlation, the persistent-transitory decomposition is only set-identified. For reasonable autoregressive moving average (ARMA) parameters the bounds for widely used objects of interest are very wide. We illustrate that these disquieting findings are of considerable practical importance, using a sample of male workers drawn from the Panel Study of Income Dynamics (PSID).

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DO - 10.3982/QE239

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The persistent-transitory representation for earnings processes

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