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Heterogeneity, Risk Sharing and the Welfare Costs of Risk

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  • Sam Schulhofer-Wohl

    (University of Chicago)

Abstract

How well do people share risk? Do non-market institutions – charity, progressive taxes, transfer payments – make up for the lack of complete insurance markets? Or is risk sharing far worse than what complete markets could achieve? Standard risk-sharing regressions assume that any variation in households’ risk preferences is uncorrelated with variation in income. I combine administrative and survey data with a simple model of imperfect insurance to show that this assumption fails; risk-tolerant workers sort into jobs where earnings carry more aggregate risk. The correlation makes previous risk-sharing regressions too pessimistic. I provide techniques that eliminate the bias, apply them to U.S. data, and find that the welfare losses from uninsured shocks are practically small and statistically difficult to distinguish from zero. In addition, because more risk-tolerant people bear more aggregate risk, the welfare costs of macroeconomic fluctuations are small even for arbitrarily risk-averse households. There is little room to improve households’ welfare by smoothing idiosyncratic or aggregate shocks unless smoothing shocks also raises mean output.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 926.

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Date of creation: 2007
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Handle: RePEc:red:sed007:926

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Cited by:
  1. Marina Pavan & Aldo Colussi, 2008. "Assessing the Impact of Public Transfers on Private Risk Sharing Arrangements. Evidence from a Randomized Experiment in Mexico," Working Papers 200807, Geary Institute, University College Dublin.
  2. Sam Schulhofer-Wohl, 2008. "Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles," Working Papers 1045, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
  3. Sarolta Laczo, 2010. "Estimating Dynamic Contracts: Risk Sharing in Village Economies," 2010 Meeting Papers 687, Society for Economic Dynamics.
  4. Sam Schulhofer-Wohl, 2011. "Heterogeneity and tests of risk sharing," Staff Report 462, Federal Reserve Bank of Minneapolis.
  5. Jae Won Lee, 2010. "Monetary Policy with Heterogeneous Households and Financial Frictions," 2010 Meeting Papers 1021, Society for Economic Dynamics.
  6. Jensen & Shore, 2008. "Changes in the Distribution of Income Volatility," 2008 Meeting Papers 82, Society for Economic Dynamics.
  7. Sam Schulhofer-Wohl & Andriy Norets, 2009. "Heterogeneity in income processes," 2009 Meeting Papers 999, Society for Economic Dynamics.
  8. Marcos Rangel & Imran Rasul & Giacomo de Giorgi & Manuela Angelucci, 2009. "Insurance, Investment, And The Extended Family," 2009 Meeting Papers 24, Society for Economic Dynamics.

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