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INVESTING RETIREMENT WEALTH: A LIFE-CYCLE MODEL – Measuring Heterogeneity in Labor Income 2

Table 3 reports the total variance of income, and its decomposition into permanent and transitory components, for each different education-industry cell. Agriculture has by far the highest variance of labor income shocks. Other industries subject to significant labor income shocks are construction and business services. The variance decomposition indicates that labor income shocks for construction workers without a high school degree are entirely temporary. At the other extreme, permanent income shocks are especially important for college graduates in public administration. As a general pattern, the relative importance of permanent shocks seems to increase with educational attainment. This was already documented for the column totals, but seems robust within individual industries.
The bottom of Table 3 splits the sample in a different way, by distinguishing selfemployed from non-self-employed households. (We included both types of households in the industry analysis, since there are too few self-employed households to allow an industry decomposition.) Income variability is dramatically larger for self-employed households. Income shocks are entirely temporary for the self-employed without a high school degree, but are disproportionately permanent for the self-employed in the two higher education groups.
Table 4 considers heterogeneity in the sensitivity of different households’ income shocks to lagged stock returns. Table 5 repeats the exercise replacing lagged stock returns with lagged returns on long-term government bonds. Unfortunately the small cell sizes mean that the results are often statistically insignificant for individual industries, but there are many interesting patterns. Stock market risk seems especially relevant for people in manufacturing, construction and public administration. Interest rate risk shows up for agriculture, professional services and finance, real-estate and insurance, in addition to the stock-market-sensitive sectors. Among college graduates, the self-employed are especially exposed to stock market risk, while interest rate risk is far more important for the non-self-employed. This finding supports the conclusion of Heaton and Lucas (1997b) that privately owned business risk is an especially important substitute for stock market risk in the portfolios of many wealthy households.