A heterogeneous household model of consumption smoothing with imperfect capital markets and income risk-sharing

This dissertation explores the choices between using capital markets and informal risk-sharing arrangements when poor households attempt to smooth their consumption in the presence both of systemic and idiosyncratic income shocks. Assuming that households have two types of instruments to smooth their consumption (i) inter-temporal reallocations of consumption, via saving and borrowing, and (ii) inter-personal risk-sharing arrangements, the objectives of this research are (i) to determine conditions that may explain the extent to which a household will employ only one or both of the two instruments available to cope with risk; (ii) to understand how these two instruments differ in their ability to smooth consumption in response to idiosyncratic and systemic income shocks; (iii) to proposes an econometric procedure, to test if and how households smooth consumption, by employing only one or both of the two instruments available to cope with risk; and (iv) to econometrically test the model using the Townsend Thai Data, to determine whether Thai households smooth consumption through inter-temporal or inter-personal mechanisms.;The current literature does not consider (i) an empirical estimation procedure that allows identifying the households' ability to smooth consumption through capital markets and informal risk-sharing mechanism; (ii) the lack of literature considering the estimation of the savings equation the consumption equation simultaneously when analyzing consumption smoothing.;I develop a structural develop a structural model of a dynamically optimizing household who faces systemic and idiosyncratic income risk and has access to borrowing, savings, informal risk-sharing, or some combination of these risk-coping mechanisms to explore the net benefits of accessing capital markets and risk-sharing. There are two main implications of the model. First, the development of capital markets explains some reasons for the existence of risk sharing. Second, households with low costs of accessing capital markets, the only difference observed between households that do not engage in risk-sharing arrangements and households that do, is that the later show a smooth saving path. I argue that in order to test for different risk sharing coping instruments, it is necessary to analyze the response to savings and consumption simultaneously.;I transform the structural model in a reduced form model that can be estimated econometrically to identify different cases of consumption smoothing, where the coefficients of the reduced forms follow some restrictions. I find four distinctive scenarios of consumption smoothing: (i) when households do not engage in risk-sharing arrangements and have low costs of accessing capital markets; (ii) when households do not engage in risk-sharing arrangements and have high costs of accessing capital markets; (iii) when households do engage in risk-sharing arrangements and face low costs of accessing capital markets, saving and/or borrowing technologies; and (iv) when households do engage in risk-sharing arrangements and face high costs of accessing capital markets.;The proposed statistical test is applied to Townsend Thai Data. The results show evidence that households surveyed either do engage in risk-sharing arrangements and face high costs of accessing capital markets or do not engage in risk-sharing arrangements and face high costs of accessing capital markets.