Intranational risk sharing and its determinants

• A model of risk sharing is developed to allow agents to pool consumption risks in both national and local markets.
• We estimate the model by employing data from China.
• The participation rate in risk sharing is low and therefore the welfare gain from reaching a perfect risk sharing is significant.
• Upon entering the market, agents pool risk in the national rather than local market.
• The degree of risk sharing depends on initial economic development and tertiary industry's contribution to GDP.

We develop a model of risk sharing in which agents can pool their consumption risks in both national and local markets and then smooth the remaining consumption fluctuations with credit markets. Estimating the model with a unique dataset on Chinese cities, we find that the participation rate in risk sharing is low, but upon entering the market, agents tend to pool risk in the national market rather than the local market. The welfare gain from reaching the perfect consumption risk sharing at the national market could be as large as 4% of the perpetual deterministic consumption flow. However, conditional on the estimated degree of risk sharing participation, the welfare gain from pooling all income risks at the national market is only 0.1%. Empirical analysis on the determinants of city risk sharing reveals that the degree of risk sharing depends on initial economic development and share of GDP contributed by tertiary industry.