Complete markets strikes back : Revisiting risk sharing tests under discount rate heterogeneity
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.
Citation
Sun , G 2013 ' Complete markets strikes back : Revisiting risk sharing tests under discount rate heterogeneity ' School of Economics and Finance Discussion Paper 1317 , no. 1317 , University of St Andrews .
ISSN
0962-4031Type
Working or discussion paper
Rights
(c) 2013 the author
Collections
Items in the St Andrews Research Repository are protected by copyright, with all rights reserved, unless otherwise indicated.