Ricardian Equivalence with Incomplete Household Risk Sharing

Several important empirical studies (e.g., Altonji, Hayashi, and Kotlikoff, 1992, 1996, 1997) find that households are not altruistically-linked in a way consistent with the standard Ricardian model, as put forward by Barro (1974). We build 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 (e.g., public redistribution) and an 'unobservable' shock that is private information (e.g., idiosyncratic wages). Parents and children observe each other's total income but not each other's effort level. In the second-best optimum, 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