Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 702: Consumption and Risk Sharing Over the Life Cycle

Kjetil Storesletten (), Chris Telmer () and Amir Yaron ()
Additional contact information
Kjetil Storesletten: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden
Chris Telmer: Graduate School of Industrial Administration, Carnegie Mellon University
Amir Yaron: Wharton School, University of Pennsylvania

Abstract: A striking feature of U.S. data on income and consumption is that inequality increases with age. Using both panel data and an equilibrium life cycle model, we argue that this is informative for understanding the importance and the characteristics of idiosyncratic labor market risk. We find that uncertainty distributed throughout the working years accounts for 40 percent of lifetime uncertainty, with the remainder being realized prior to entering the labor market. We estimate that shocks received over the life cycle cointain a highly persistent component, with an autocorrelation coefficient between 0.98 and unity. The joint behavior of earnings and consumption inequality, interpreted using our model, adds to the body of evidence suggesting that labor market risk are imperfectly pooled and that a precautionary motive is an important aspect of U.S. savings behavior. The restrictions imposed by general equilibrium theory play an important role in arriving at each of these conclusions.

Keywords: Risk sharing; income and consumption inequality; idiosyncratic risk

JEL-codes: D31; E21

52 pages, February 12, 2002

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