Insuring Consumption Using Income-Linked Assets

46 Pages Posted: 22 Mar 2010

See all articles by Andreas Fuster

Andreas Fuster

Swiss National Bank - Financial Stability

Paul Willen

Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2010

Abstract

Shiller (2003) and others have argued for the creation of financial instruments that allow individuals to insure risks associated with their lifetime labor income. In this paper, we argue that while the purpose of such assets is to smooth consumption across states of nature, one must also consider the assets' effects on households' ability to smooth consumption over time. We show that consumers in a realistically calibrated life-cycle model would generally prefer income-linked loans (with a rate positively correlated with income shocks) to an income-hedging instrument (a limited liability asset whose returns correlate negatively with income shocks) even though the assets offer identical opportunities to smooth consumption across states. While for some parameterizations of our model the welfare gains from the presence of income-linked assets can be substantial (above 1% of certainty-equivalent consumption), the assets we consider can only mitigate a relatively small part of the welfare costs of labor income risk over the life cycle.

Suggested Citation

Fuster, Andreas and Willen, Paul S., Insuring Consumption Using Income-Linked Assets (March 2010). NBER Working Paper No. w15829, Available at SSRN: https://ssrn.com/abstract=1574648

Andreas Fuster (Contact Author)

Swiss National Bank - Financial Stability ( email )

Boersenstrasse 15
Zurich, CH-8022
Switzerland

Paul S. Willen

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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