Income Dynamics and Consumption Insurance

Income Dynamics and Consumption Insurance

By Iourii Manovski and Dmytro Hryshko


An accurate quantitative analysis using lifecycle incomplete markets models requires that they match both the total amount of insurance available to households in the data and the empirical importance of the sources of insurance such as, e.g., household saving and borrowing or the tax and transfer system. The prominent empirical benchmark estimates of the extent and sources of insurance provided in Blundell, Pistaferri and Preston (American Economic Review, 2008) imply that the currently used models poorly fit these data. We show that this is because the income process used as an input in the incomplete markets models and when constructing the empirical benchmark estimates of insurance abstracts from the irregular nature of income observations at the start and end of family income spells. When ignored, this feature of the income data induces a large bias in the empirical measures of the degree and sources of insurance and results in a misleading assessment of the models’ performance. The empirical measures of insurance accounting for the bias imply a limited role of assets and taxes and transfers in insuring permanent shocks to household budgets.

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