Ricardian Equivalence with Incomplete Household Risk Sharing: Technical Paper 2002-4

Working Paper
November 2, 2002

Shinichi Nishiyama and Kent Smetters

Several important empirical studies (for example, Altonji, Hayashi, and Kotlikoff, 1992, 1996, 1997) have found that households are not altruistically linked in a way consistent with the standard Ricardian model, as put forward by Barro (1974). We built a two-sided altruistic-linkage model in which private transfers are made in the presence of two types of shocks: an observable shock that is public information (for example, public redistribution) and an unobservable shock that is private information (for example, idiosyncratic wages). Parents and children observe each other s total income but not each other's effort level. In the second-best solution, unobservable shocks are only partially shared, whereas, for any utility function satisfying a condition derived herein, observable shocks are fully shared. The model, therefore, can generate the low degree of risk sharing found in the recent studies, but Ricardian equivalence still holds.