Wednesday, April 18, 2012

Confirmation, 26 Years Later

A new paper on cyclical income risk reports the following:
we study the cyclical nature of idiosyncratic shocks, once observable factors are accounted for. Contrary to past research, we find that income shock variances are not countercyclical. However, uncertainty does have a significant countercyclical component, but it comes from the left-skewness increasing during recessions. That is, during recessions, the upper end of the income shock distribution collapses—large upward income movements become less likely—whereas the bottom end expands—large drops in incomes become more likely....Our findings are more in line with the way Mankiw (1986) modeled idiosyncratic shocks. Basically, he showed that one can resolve the equity premium puzzle if idiosyncratic shocks have countercyclical left-skewness—as found in the current paper.