Essays on Income Volatility and Household Behavior

Abstract

This dissertation contains two essays in labor economics. It provides a descriptive analysis on income volatility and develops a microeconomic model to study how married couples make joint decisions in response to such income volatility. The first essay examines the recent trends in household income volatility in the United States, West Germany and Great Britain, and compares household income volatility with individual income volatility. I estimate a formal error components model using the Cross-national Equivalence File from 1979 to 2004. I find that household income volatility, measured by the transitory variance of household income, accounts for more than half of the total income variance for all three countries. Despite the differences in the total household income variances among the three countries, the permanent variances converges since the late 1990s. The household earnings volatility is always lower than the individual earnings volatility for married couples, which suggests some evidence of intra-household insurance. In the second essay I examine whether married couples make joint labor supply decisions in response to each other's wage shocks. The study of this question aids in understanding the link between the recent rise in earnings volatility and household joint decisions. I develop an intra-household insurance model based on the collective framework, which allows for insurance against both permanent and transitory wage shocks from both partners. Estimation using Survey of Income and Program Participation shows that individuals increase labor supply in response to spouse's adverse wage shocks and such labor supply responses are larger when shocks are permanent than transitory. A household makes less transfer to the individual with more volatile income, which can be considered as a price for insurance.This intra-household insurance reduces earnings volatility by about 1.2% to 7.7%. These results suggest that joint labor supply decisions provide a smoothing effect on shocks to earnings and household income.