How Much Consumption Insurance Beyond Self-Insurance?

44 Pages Posted: 8 Dec 2009 Last revised: 5 Jul 2010

See all articles by Greg Kaplan

Greg Kaplan

New York University

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: December 2009

Abstract

We assess the degree of consumption smoothing implicit in a calibrated life-cycle version of the standard incomplete-markets model, and we compare it to the empirical estimates of Blundell et al. (2008) (BPP hereafter). We find that households in the model have access to less consumption-smoothing against permanent earnings shocks than what is measured in the data. BPP estimate that 36% of permanent shocks are insurable (i.e., do not translate into consumption growth), whereas the model's counterpart of the BPP estimator varies between 7% and 22%, depending on the tightness of debt limits. In the model, the age profile of the insurance coefficient is sharply increasing, whereas BPP find no clear age slope in their estimate. Allowing for a plausible degree of "advance information" about future earnings does not reconcile the model-data gap. If earnings shocks display mean reversion, even with very high autocorrelation, then the average degree of consumption smoothing in the model agrees with the BPP empirical estimate, but its age profile remains steep. Finally, we show that the BPP estimator of the true insurance coefficient has, in general, a downward bias that grows as borrowing limits become tighter.

Suggested Citation

Kaplan, Greg and Violante, Giovanni L., How Much Consumption Insurance Beyond Self-Insurance? (December 2009). NBER Working Paper No. w15553. Available at SSRN: https://ssrn.com/abstract=1518746

Greg Kaplan (Contact Author)

New York University ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Giovanni L. Violante

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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