International and intranational consumption risk sharing: the evidence for the UK and OECD

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 10 July 2006

Working Paper No. 302
By Vincent Labhard and Michael Sawicki

'Consumption risk sharing' refers to the ability of agents to insure or protect their consumption against shocks to their income, for example, by borrowing and lending or holding claims on foreign equity. So measuring the extent of risk sharing informs us about how consumption is likely to respond to country or region-specific shocks to income. This paper presents the evidence for consumption risk sharing by UK consumers, both across regions of the United Kingdom (intranationally) and between the United Kingdom and other countries (internationally). The main motivation for collecting this evidence is to establish to what extent UK consumers insure against income risks, and whether they do so to the same extent intranationally and internationally. Such evidence can tell us whether risk sharing functions effectively as an absorber of country or region-specific shocks in the United Kingdom. We find that there is more risk sharing across the UK regions than between the United Kingdom and other OECD countries. To test the robustness of our conclusions, we document the evidence for risk sharing using recent econometric techniques, which allow explicitly for country or region-specific factors impacting on consumption and output, including measurement errors in the data. We find that our results remain robust when we account for the possible impact of measurement error and preference shocks, and are consistent with results reported in the existing literature. Additionally, our paper also makes a separate contribution to the literature by illustrating the role of the choice of deflators in estimating the true extent of risk sharing for the United Kingdom and OECD. In terms of the channels through which risk sharing occurs, we find that the main mechanism of regional risk sharing operates via cross-regional asset holdings. Internationally, the main source of income smoothing comes from international borrowing and lending.

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