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.
income distribution; income dynamics; relative entropy
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