Pareto Models for Top Incomes

Arthur Charpentier (1, 2) , Emmanuel Flachaire (3)

1 CREM - Centre de recherche en économie et management
2 DMS - Département de Mathématiques et de statistique [UdeM- Montréal]
3 EUREQUA - Equipe Universitaire de Recherche en Economie Quantitative

Top incomes are often related to Pareto distribution. To date, economists have mostly used Pareto Type I distribution to model the upper tail of income and wealth distribution. It is a parametric distribution, with an attractive property, that can be easily linked to economic theory. In this paper, we first show that modelling top incomes with Pareto Type I distribution can lead to severe over-estimation of inequality, even with millions of observations. Then, we show that the Generalized Pareto distribution and, even more, the Extended Pareto distribution, are much less sensitive to the choice of the threshold. Thus, they provide more reliable results. We discuss different types of bias that could be encountered in empirical studies and, we provide some guidance for practice. To illustrate, two applications are investigated, on the distribution of income in South Africa in 2012 and on the distribution of wealth in the United States in 2013.

Mots clés: Pareto distribution; top incomes; inequality measures

Domaines: Statistiques [math.ST]; Economies et finances

Arthur Charpentier, Emmanuel Flachaire. Pareto Models for Top Incomes. 2019. ⟨hal-02145024⟩