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American Economic Journal: Macroeconomics: Vol. 5 No. 4 (October 2013)

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The Wrong Shape of Insurance? What Cross-Sectional Distributions Tell Us about Models of Consumption Smoothing

Article Citation

Broer, Tobias. 2013. "The Wrong Shape of Insurance? What Cross-Sectional Distributions Tell Us about Models of Consumption Smoothing." American Economic Journal: Macroeconomics, 5(4): 107-40.

DOI: 10.1257/mac.5.4.107

Abstract

This paper shows how two standard models of consumption risk-sharing—self-insurance through borrowing and saving and limited commitment to insurance contracts—replicate similarly well the standard, second-moment measures of insurance observed in US micro data. A nonparametric analysis, however, reveals strongly contrasting and counterfactual joint distributions of consumption, income and wealth. Method of moments estimation shows how measurement error in consumption eliminates excessive skewness and smoothness of consumption growth. Moreover, counterfactual nonlinearities disappear at high-estimated risk aversion under selfinsurance, but are a robust feature of limited commitment. Its "shape of insurance" thus argues in favor of the self-insurance model.

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Authors

Broer, Tobias (Institute for International Economic Studies, Stockholm U)

JEL Classifications

D14: Personal Finance
D81: Criteria for Decision-Making under Risk and Uncertainty
D91: Intertemporal Consumer Choice; Life Cycle Models and Saving
E21: Macroeconomics: Consumption; Saving; Wealth
G22: Insurance; Insurance Companies

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