Creator: Lepetyuk, Vadym and Stoltenberg, Christian Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 705 Abstract:
The rise in within-group consumption inequality in response to the increase in within-group income inequality over the last three decades in the U.S. is puzzling to expected-utility-based incomplete market models. The two-sided lack of commitment models exhibit too little consumption inequality while the standard incomplete markets models tend to predict too much consumption inequality. We show that a model with two-sided lack of commitment and chance attitudes, as emphasized by prospect theory, can explain the relationship and can avoid the systematic bias of the expected utility models. The chance attitudes, such as optimism and pessimism, imply that the households attribute a higher weight to high and low outcomes compared to their objective probabilities. For realistic values of risk aversion and of chance attitudes, the incentives for households to share the idiosyncratic risk decrease. The latter effect endogenously amplifies the increase in consumption inequality relative to the expected utility model, thereby improving the fit to the data.
Keyword: Risk sharing, Consumption inequality, Prospect theory, and Limited enforcement Subject (JEL): D52 - Incomplete Markets, D31 - Personal Income, Wealth, and Their Distributions, and E21 - Macroeconomics: Consumption; Saving; Wealth
Creator: Ales, Laurence and Maziero, Pricila Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 663 Abstract:
We study the quantitative properties of constrained efficient allocations in an environment where risk sharing is limited by the presence of private information. We consider a life cycle version of a standard Mirrlees economy where shocks to labor productivity have a component that is public information and one that is private information. The presence of private shocks has important implications for the age profiles of consumption and income. First, they introduce an endogenous dispersion of continuation utilities. As a result, consumption inequality rises with age even if the variance of the shocks does not. Second, they introduce an endogenous rise of the distortion on the marginal rate of substitution between consumption and leisure over the life cycle. This is because, as agents age, the ability to properly provide incentives for work must become less and less tied to promises of benefits (through either increased leisure or consumption) in future periods. Both of these features are also present in the data. We look at the data through the lens of our model and estimate the fraction of labor productivity that is private information. We find that for the model and data to be consistent, a large fraction of shocks to labor productivities must be private information.
Keyword: Risk sharing, Consumption inequality, and Private information Subject (JEL): D58 - Computable and Other Applied General Equilibrium Models, D86 - Economics of Contract: Theory, D11 - Consumer Economics: Theory, D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, D82 - Asymmetric and Private Information; Mechanism Design, and H21 - Taxation and Subsidies: Efficiency; Optimal Taxation