Complete markets strikes back: Revisiting risk sharing tests under discount rate heterogeneity

Gang Sun

    Research output: Working paper

    4 Downloads (Pure)

    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.
    Original languageEnglish
    PublisherUniversity of St Andrews
    Number of pages23
    Publication statusPublished - Feb 2013

    Publication series

    NameSchool of Economics and Finance Discussion Paper 1317
    No.1317
    ISSN (Print)0962-4031
    ISSN (Electronic)2055-303X

    Keywords

    • Complete markets
    • Discount heterogeneity
    • Risk sharing

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