Bank of Lithuania
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No 108

Advance Information and Consumption Insurance: Evidence and Structural Estimation

  • Abstract

    We show that advance information on future income can be identified from the correlation between consumption growth and future income growth conditional on current income growth. Employing PSID data, we find that this conditional correlation is positive and significant. We use this evidence to structurally estimate a standard incomplete markets model and discover that US households possess enough advance information to reduce their income forecast errors by 15%. This significantly affects the measurement of consumption insurance. With advance information, 25% more income shocks pass through to consumption on average, and more than twice as much for the 5% asset poorest.

    Keywords: income risk, advance information, consumption insurance, panel data, incomplete markets.

    JEL Classification: C23, D12, D31, D52, D81, E21, G52.