Econometrica: Jul 2011, Volume 79, Issue 4

Risk Sharing in Private Information Models With Asset Accumulation: Explaining the Excess Smoothness of Consumption

https://doi.org/10.3982/ECTA7063
p. 1027-1068

Orazio P. Attanasio, Nicola Pavoni

We study testable implications for the dynamics of consumption and income of models in which first‐best allocations are not achieved because of a moral hazard problem with hidden saving. We show that in this environment, agents typically achieve more insurance than that obtained under self‐insurance with a single asset. Consumption allocations exhibit “excess smoothness,” as found and defined by Campbell and Deaton (1989). We argue that excess smoothness, in this context, is equivalent to a violation of the intertemporal budget constraint considered in a Bewley economy (with a single asset). We also show parameterizations of our model in which we can obtain a closed‐form solution for the efficient insurance contract and where the excess smoothness parameter has a structural interpretation in terms of the severity of the moral hazard problem. We present tests of excess smoothness, applied to U.K. microdata and constructed using techniques proposed by Hansen, Roberds, and Sargent (1991) to test the intertemporal budget constraint. Our theoretical model leads us to interpret them as tests of the market structure faced by economic agents. We also construct a test based on the dynamics of the cross‐sectional variances of consumption and income that is, in a precise sense, complementary to that based on Hansen, Roberds, and Sargent (1991) and that allows us to estimate the same structural parameter. The results we report are consistent with the implications of the model and are internally coherent.

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Supplement to "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption"

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Supplement to "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption"

This document contains two main sections which correspond to Appendix B and Appendix C in the main text.  In the first section we formally derive the closed forms presented in Sections 3.2 and 3.3 in the main text.  In the second section, we derive the expression for the bias in the variance induced by the use of a pseudo-panel (such as the one we consider in our estimations).

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