Income Dynamics with a Stationary Double Pareto Distribution

At Yale, third year PhD students were required to write an empirical paper. When I was third year in 2010, my initial intention was to see whether income is exponentially distributed, which is an implication of my earlier paper Toda (2010). Upon inspecting CPS data, I found that the income distribution has both upper and lower Pareto tails. I thought about the rationalization and noticed that the stochastic differential equation used in Alfarano et al. (2012) (which was then a 2008 working paper) can rationalize it, so I applied this mechanism. My interest in power laws started around this time.

This is an abridged version intended for physicists, and the full version was published as Toda (2012).