Income volatility, household leverage, and consumption in Korea

Using the micro household data in Korea, we examine the effects of income volatility changes on households’ leverage and consumption. We found that households who faced increased income volatility lowered their leverage ratio. A one standard deviation increase in income volatility was associated with 1.3 ∼ 1.5 percentage point decrease in the leverage ratio. The effects of income volatility changes on households’ leverage choices varied with households’ borrowing constraints and other socioeconomic backgrounds. We also found that when faced with enlarged income uncertainty, households’ income coefficients on consumption were lowered. The income coefficient of average households was estimated to be around 0.16, while households with increased income volatility were around 0.12. In particular, similar to the relations in leverage ratio changes, consumptions among potentially borrowing-constrained households and those with ‘net-short’ position in real estate assets were more affected by increases in income volatility. This can be understood that households smoothed their consumption during the periods of increased income volatility, and this was shown in the smaller consumption elasticity on income. This can be attributed to the fact that faced with increased income volatility, households lower the risk exposure of their financial net wealth by lowering their leverage ratio.