Working Paper: CEPR ID: DP8701
Authors: Tobias Broer
Abstract: This paper shows how two standard models of consumption risk-sharing - self-insurance through borrowing and saving and limited commitment to insurance contracts - replicate similarly well the standard, second-moment measures of insurance observed in US micro-data. A non-parametric analysis, however, reveals strongly contrasting and counterfactual joint distributions of consumption, income and wealth. Method of moments estimation shows how measurement error in consumption eliminates excessive skewness and concentration of consumption growth. Moreover, counterfactual non-linearities disappear at high estimated risk-aversion under self-insurance, but are a robust feature of limited commitment. Its "shape of insurance" thus argues strongly in favour of the self-insurance model.
Keywords: Limited Commitment; Risk Sharing; Wealth and Consumption Distribution
JEL Codes: D31; D52; E21; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| joint distribution of consumption and income under both the limited commitment model and the self-insurance model (D10) | low conditional variance of consumption growth (E21) |
| measurement error in consumption (D12) | misrepresentation of the dynamics between consumption and income (E21) |
| self-insurance model (G52) | better explanation of observed data (C29) |
| limited commitment model (D10) | strongly counterfactual nonlinearities in consumption growth responses (E21) |
| self-insurance model's predictions (G52) | consistency with observed data (C52) |