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Heterogeneity and Tests of Risk Sharing

Staff Report 462 | Published September 13, 2011

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Heterogeneity and Tests of Risk Sharing


How well do people share risk? Standard risk-sharing regressions assume that any variation in households’ risk preferences is uncorrelated with variation in the cyclicality of income. I combine administrative and survey data to show that this assumption is questionable: Risk-tolerant workers hold jobs where earnings carry more aggregate risk. The correlation makes risk-sharing regressions in the previous literature too pessimistic. I derive techniques that eliminate the bias, apply them to U.S. data, and find that the effect of idiosyncratic income shocks on consumption is practically small and statistically difficult to distinguish from zero.

Published in: _Journal of Political Economy_ (Vol. 119, No. 5, October 2011, pp. 925-958)