Income Dynamics, Income Risk, and Income Risk-Sharing – 2014
September 26, 2014 - September 27, 2014
Income risk is arguably the largest source of risk faced by individuals. Because income risk can be understood as a possible gap between realized income and expected income – and the latter is typically not observed – income risk must be inferred from other sources. Under the view that income changes are frequently unpredictable, income dynamics are often used by economists to estimate income volatility, an observable proxy for income risk. The question of how income risk is managed and shared is critical for a few reasons. Since income risk is largely idiosyncratic, complete markets would allow them to be traded and diversified away. As a result, the absence of perfect risk sharing indicates a barrier to the creation of such markets, such as adverse selection or moral hazard. Without such formal markets, informal risk-sharing mechanisms such as intra-household risk-sharing may be important.