Intertemporal risk pooling in village economies

We propose an improved theoretically-grounded method to test for efficient risk pooling that allows for intertemporal smoothing, non-homothetic consumption, and heterogeneous risk and time preferences. Applying this method to recent panel data from Indian villages generates important new insights while confirming some earlier findings. Year-to-year smoothing of consumption takes place much more at the village level than at the individual level and occurs primarily through financial assets. While there is proportionally more smoothing of food than non-food consumption, accounting for differences in income elasticities between the two statistically eliminates this difference, indicating that risk pooling does not distort consumption choices in our study area. Finally, we find that consumption smoothing is affected jointly by income and liquid assets, and that there is no excess sensitivity to earned income.