Channels of Risk Sharing at Micro Level: Savings, Investments and Risk Aversion Heterogeneity

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Abstract
Applying the standard income variance decomposition methodology, 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 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 analyse the issue of risk sharing by income, education levels and 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 more stable savings rate (like the Scottish population), regardless of their economic conditions. Copyright © 2015 John Wiley & Sons, Ltd.

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