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How does Household Consumption Respond to Income Shocks? Evidence and Theory

  • Fabrizio Perri

    (University of Minnesota)

  • Dirk Krueger

    (University of Pennsylvania)

n this paper we first use the Italian Survey of Household Income and Wealth to document how various household choices (including consumption and wealth) change in response to an income change. We show that these responses are not consistent with simple benchmark models (i.e. complete markets or hands to mouth consumers). In particular, we find evidence of significant asymmetries in how consumption and wealth respond to income change. We also find that these responses have changed significantly over time. We then explore how existing partial risk sharing models can account for this evidence. Preliminary work suggest that such a model, especially if one wants to explain more recent data, will have to include better insurance means than the standard incomplete markets but substantially less than a model with a full set of contingent assets.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 910.

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Date of creation: 2008
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Handle: RePEc:red:sed008:910
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/society.htm
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  1. Fernando Alvarez & Urban J. Jermann, . "Quantitative Asset Pricing Implications of Endogenous Solvency Constraints," Rodney L. White Center for Financial Research Working Papers 10-99, Wharton School Rodney L. White Center for Financial Research.
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  9. Zhang, H.H., 1995. "Endogenous Borrowing Constraints with Incomplete Markets," GSIA Working Papers 1995-25, Carnegie Mellon University, Tepper School of Business.
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  13. Joseph G. Altonji & Aloysius Siow, 1987. "Testing the Response of Consumption to Income Changes with (Noisy) Panel Data," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 293-328.
  14. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-56, October.
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  16. Shea, John, 1995. "Union Contracts and the Life-Cycle/Permanent-Income Hypothesis," American Economic Review, American Economic Association, vol. 85(1), pages 186-200, March.
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