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How do households smooth earnings fluctuations: what can we learn from Consumer Expenditure Data?

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  • Fabrizio Perri
  • Dirk Krueger

Abstract

In this paper we demonstrate that different incomplete markets models yield qualitatively distinct predictions about how consumption growth responds to declines and increases in earnings. Markets are either exogenously incomplete in that households can only trade a risk-free bond, subject to a possibly binding borrowing constraint, or endogenously incomplete due to enforcement or informational frictions that prevent perfect risk sharing. We then use earnings and consumption data from the 1980 to 2000 Consumer Expenditure Survey to empirically test these implications about the asymmetric consumption responses to positive and negative earnings growth, in order to assess which form of market incompleteness approximates individual consumption smoothing opportunities best

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 683.

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Date of creation: 2004
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Handle: RePEc:red:sed004:683

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Keywords: Consumption Insurance; Income Shocks; Incomplete Markets;

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