Cyclical Dynamics in Idiosyncratic Labor- Market Risk

We ask how idiosyncratic labor-market risk varies over the business cycle. A difficulty in addressing this question is the limited time-series dimension of existing panel data sets. We address this difficulty by developing a GMM estimator which conditions on the macroeconomic history experienced by each member of the panel. Variation in the cross-sectional variance between households with differing macroeconomic histories allows us to incorporate business-cycle information dating back to 1930, even though our data only begins in 1968. We implement this estimator using household-level labor-earnings data from the Panel Study on Income Dynamics. We estimate that idiosyncratic risk is (i) highly persistent, with an autocorrelation coefficient of 0.95, and (ii) strongly countercyclical, with a conditional standard deviation that increases by 75% (from 0.12 to 0.21) as the macroeconomy moves from peak to trough.