Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption

We derive testable implications of model in which first best allocations are not achieved because of a moral hazard problem with hidden saving. We show that in this environment agents typically achieve more insurance than that obtained under autarchy via saving, and that consumption allocation gives rise to 'excess smoothness of consumption', as found and defined by Campbell and Deaton (1987). We argue that the evidence on excess smoothness is consistent with a violation of the simple intertemporal budget constraint considered in a Bewley economy (with a single asset) and use techniques proposed by Hansen et al. (1991) to test the intertemporal budget constraint. We also construct closed form examples where the excess smoothness parameter has a structural interpretation in terms of the severity of the moral hazard problem. Evidence from the UK on the dynamic properties of consumption and income in micro data is consistent with the implications of the model.