Simple Approximations and Interpretation of Pareto Index and Gini Coefficient Using Mean Absolute Deviations and Quantile Functions

eugene pinsky, Qifu Wen

Abstract: The Pareto distribution has been widely used to model income distribution and inequality. The tail index and the Gini index are typically computed by iteration using Maximum Likelihood and are usually interpreted in terms of the Lorenz curve. We derive an alternative method by considering a truncated Pareto distribution and deriving a simple closed-form approximation for the tail index and the Gini coefficient in terms of the mean absolute deviation and weighted quartile differences. The obtained expressions can be used for any Pareto distribution, even without a finite mean or variance. These expressions are resistant to outliers and have a simple geometric and "economic" interpretation in terms of the quantile function and quartiles. Extensive simulations demonstrate that the proposed approximate values for the tail index and the Gini coefficient are within a few percent relative error of the exact values, even for a moderate number of data points. Our paper offers practical and computationally simple methods to analyze a class of models with Pareto distributions. The proposed methodology can be extended to many other distributions used in econometrics and related fields.