An investigation of consumption insurance over the life cycle

One of the most pervasive question in the economics of consumption is: to what extent can consumers insure against income fluctuations? In this dissertation, I have adressed this question from several angles. In Chapter 1, I study the amount of consumption insurance present in Spanish households. I address this subject using the Spanish Household Budget Survey, which is a panel dataset with information on consumption and income at the quarterly frequency. I document the joint dynamics of consumption and income for Spanish households over the life cycle. I find that the ability of households to smooth income shocks changes with age. In particular, the transmission of permanent shocks to consumption decreases with age, from full transmission at 25 to less than 40% at 60. In turn, the transmission of transitory shocks is low throughout the life cycle. Chapter 2 studies the transmission of income shocks into nondurable consumption in the presence of durable goods. We use a standard a life-cycle model with two goods to characterize the interaction of durability of goods, durability of shocks, and borrowing constraints as determinants of shock transmission. We show that borrowing constraints lead to a substitution between durable and non-durable goods upon arrival of an unexpected income change. This substitution biases the conventional measures of insurance based on the response of non-durable consumption to income changes. The sign of this bias depends critically on the persistence of the shock. We show that households have less insurance against transitory shocks and more insurance against permanent shocks than commonly measured. We calibrate the model economy to the US in order to measure the size of this bias and find it to be overall moderate, but realtively important for younger households. Finally, in Chapter 3, I use the Spanish Household Budget Survey to characterize the decision to purchase durable goods in the presence of adjustment costs and employment status risk. I document both the discrete decision (to purchase or not) and the intensity of purchases (the fraction of total expenditures allocated to durable goods) for several groups of the population. Permanent differences in income, measured by differences in education, lead 81 to differences in the frequency of purchases, but not in its relative intensity. Unemployment, on the other hand, leads to a reduction in both the frequency and the intensity of durable goods purchases. These findings are consistent with the presence of non-convex adjustment costs for durable goods and a limited persistence of unemployment risk.