Time-varying unobserved heterogeneity in earnings shocks

This paper considers the transitory-permanent model for the earnings process, and allows for time-varying individual-specific unobserved heterogeneity in each shock. The cross-sectional heterogeneity in each shock is drawn from an unknown distribution at each time period. Sufficient conditions for the nonparametric identification of the cross-sectional density functions of the heterogeneity are provided, under different assumptions on the time series behavior of the transitory shock. The method proposed is then applied to earnings data to document a high degree of cross-sectional heterogeneity in each shock.