Understanding Consumption Smoothing: Evidence from the US Consumer Expenditure Data∗

Consumption models with endogenous debt constraints differ from standard incomplete markets models in their predictions about an individual household’s ability to smooth consumption across time and states of the world. In this paper we develop these differences, both theoretically and quantitatively. We then use data from the US Consumer Expenditure Survey (CE) to assess along which dimensions the predictions of these models are consistent with the empirical evidence. We find that both types of models fail to fully account for the data and argue that a model that combines aspects of both might be more succesfull. keywords: Risk Sharing, Insurance, Incomplete Markets, Limited Enforcement, Earning Shocks, Asymmetries jel classification codes: E21, D91, D63, D31,G22 ∗ Aknowledgements: An earlier and substantially different version of this paper circulated under the title “Risk Sharing in Economies with Incomplete Markets”. We thank an anonymous referee and seminar participants at the University of Chicago, Stanford University, the 2004 SED and EEA meetings for helpful comments. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Krueger acknowledges financial support from the NSF under grant SES-0004376. ∗∗ Email addresses: Krueger [email protected], Perri [email protected]