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Complete Markets Strikes Back: Revisiting Risk Sharing Tests under Discount Rate Heterogeneity

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  • Gang Sun

    () (University of St Andrews)

Abstract

Recent risk sharing tests strongly reject the hypothesis of complete markets, because in the data: (1) the individual consumption comoves with income and (2) the consumption dispersion increases over the life cycle. In this paper, I revisit the implications of these risk sharing tests in the context of a complete market model with discount rate heterogeneity, which is extended to introduce the individual choices of effort in education. I find that a complete market model with discount rate heterogeneity can pass both types of the risk sharing tests. The endogenous positive correlation between income growth rate and patience makes the individual consumption comove with income, even if the markets are complete. I also show that this model is quantitatively admissible to account for both the observed comovement of consumption and income and the increase of consumption dispersion over the life cycle.

Suggested Citation

  • Gang Sun, 2012. "Complete Markets Strikes Back: Revisiting Risk Sharing Tests under Discount Rate Heterogeneity," Discussion Paper Series, Department of Economics 201317, Department of Economics, University of St. Andrews, revised 26 Feb 2013.
  • Handle: RePEc:san:wpecon:1317
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    References listed on IDEAS

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    Cited by:

    1. Sun, Gang, 2013. "Consumption Inequality and Discount Rate Heterogeneity," SIRE Discussion Papers 2013-97, Scottish Institute for Research in Economics (SIRE).
    2. Gang Sun, 2013. "Consumption Inequality and Discount Rate Heterogeneity," Discussion Paper Series, Department of Economics 201318, Department of Economics, University of St. Andrews.

    More about this item

    Keywords

    complete markets; discount rate heterogeneity; risk sharing;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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