Disentangling Insurance and Information in Intertemporal Consumption Choices

This paper combines panel data on income realizations and quantitative subjective expectations of future income to identify anticipated and unanticipated components of income changes. It shows that, in more general settings, data on income and consumption are not sufficient to separately identify advance information that consumers may have about their income from the extent of consumption insurance against income innovations. The addition of subjective income expectations solves the identification problem. The paper shows that the degree of insurance of income shocks is upward biased. Hence, the difference in information sets between the individual and the econometrician can potentially explain the empirical puzzle of excess consumption smoothness. The paper finds that a large part of the transitory variation in income is either anticipated or the result of measurement error, while about two-thirds of the permanent variation in income can be labeled as a true innovation.