Income and Consumption: a Micro Semistructural Analysis with Pervasive Heterogeneity

We develop a model of consumption and income that allows for pervasive heterogeneity in the parameters of both processes. Introducing co-dependence between household income parameters and preference parameters, we also allow for heterogeneity in the impact of income shocks on consumption. We estimate the parameters of the model using a sample from the PSID, covering the period 1968 to 2009. We find considerable co-dependent heterogeneity in the parameters governing income and consumption processes. Our results suggest a great deal of heterogeneity in the reaction of consumption to income shocks, highlighting the heterogeneity in the self-insurance available to households.