Income Smoothing and Consumption Smoothing

TLDR

Risk‑averse households protect consumption by borrowing, insurance, or diversifying activities, yet these mechanisms are usually studied separately, limiting insights that could be gained by examining them jointly. The study aims to provide a comprehensive view of risks, costs, and insurance options, and to enable assessment of biases in standard credit and insurance tests.

Abstract

One way that risk-averse households protect consumption levels is to borrow and use insurance mechanisms. Another way, common in low-income economies, is to diversify economic activities and make conservative production and employment choices. Households thus tend toward limiting exposure only to shocks that can be handled with available credit and insurance. Typically, both types of mechanisms are studied independently but much more can be learned by studying them together. First, we obtain a more complete picture of risks, costs, and insurance possibilities. Second, it opens the way to considering biases in standard tests of credit and insurance.