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

  • Gang Sun

    ()

    (University of St Andrews)

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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.

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Paper provided by Department of Economics, University of St. Andrews in its series Discussion Paper Series, Department of Economics with number 201317.

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Date of creation: 15 Oct 2012
Date of revision: 26 Feb 2013
Handle: RePEc:san:wpecon:1317
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