Are the Poor More Vulnerable to Income Shocks

This paper examines the extent of consumption insurance against income risk by households in rural India. We estimate the effects of income changes on consumption after controlling for aggregate shocks through changes in village level consumption and household size. We also test whether there is a systematic wealth effect on the extent of consumption insurance against idiosyncratic income shocks by classifying the households on the basis of landholding, which is the primary source of wealth for rural households in India. The null hypothesis of full insurance is rejected both for the population as a whole and for the different land classes. Our estimation results also show that consumption tracks income more closely for the poorer households – the estimated marginal propensity to consume out of idiosyncratic changes in income is significantly higher for the poorer households compared to the richer households. The results are robust to alternative estimation methodologies and alternative methods of sample stratification.