Measuring Wealth: Income Capitalization with Heterogeneous Rates of Return

Bozbay I., Halvorsen E., Iacono R., and Vesperoni A.

In many countries, the income distribution is well-understood from tax data while the wealth distribution is unknown and typically proxied by surveys. This paper develops a method to estimate the unknown wealth distribution from the observed income distribution. Our approach is an extension of the well-known income capitalization method that, using the same data input, delivers a richer estimation by introducing theoretical structure. Specifically, in contrast to the income capitalization method and in line with empirical evidence, our method takes into account and estimates the heterogeneous rates of return by assuming asset complementarities in the household production functions, so that higher investments may breed higher returns via portfolio composition. In an empirical application, the proposed method is tested with Norwegian data where both income and wealth are observed at the household level, verifying that the predicted wealth levels are a better proxy for the observed ones compared to the original income capitalization method.

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