Heterogeneity and Tests of Risk Sharing

How well do people share risk? Do non-market institutions – charity, progres-sive taxes, transfer payments – make up for the lack of complete insurance markets? Or is risk sharing far worse than what complete markets could achieve? Standard risk-sharing regressions assume that any variation in households ’ risk preferences is uncorrelated with variation in income. I combine administrative and survey data to show that this assumption fails; risk-tolerant workers hold jobs where earnings carry more aggregate risk. The correlation makes risk-sharing regressions in the previous literature too pessimistic. I derive techniques that eliminate the bias, apply them to U.S. data, and find that the effect of idiosyncratic income shocks on consumption is practically small and statistically difficult to distinguish from zero