Channels of risk-sharing at a micro level: savings, investments and the risk aversion heterogeneity

Abstract

Applying the variance decomposition developed by Asdrubali et al. (1996), the paper explores for the first time the role and the extent of smoothing channels at a micro level using a sample of UK households. Our empirical analysis of British Household Panel Survey (BHPS) data concludes that the bulk of risk-sharing in the UK is driven by the savings channel. By allowing for risk aversion heterogeneity, we detect an inverted U-shaped relationship between risk aversion and the extent of smoothing achieved through financial markets. We also analyze the issue of risk-sharing by income, education levels and by region. We find that risk-sharing is more effective (higher) for individuals whose savings are more flexible, while it is less effective (lower) for individuals characterized by relatively more stable savings rate (like the Scottish population), regardless of their economic conditions.