Nonparametric Heteroskedasticity in Persistent Panel Processes: An Application to Earnings Dynamics∗

In a standard model of earnings dynamics, we allow heterogeneous earnings risk to depend on unobserved permanent earnings. We show the nonparametric identification of earnings risk, as well as of the densities of the permanent and transitory components of earnings. Applying our model to the Panel Survey of Income Dynamics (PSID), we find that earnings dispersion depends in a nontrivial way on the past permanent earnings. Dur-ing the three recent recessions we analyze, we find that workers with lower pre-recession permanent earnings have higher earnings risk. One important implication of our findings is path-dependent heterogeneous consumption growth rates under precautionary savings