This dissertation investigates the consumption smoothing ability of households when they are hit by uninsurable income shocks. The first chapter investigates what is the true extent of income shocks to individuals, particularly for the female. Previous literature has focused exclusively on the residual uncertainty on male earnings, neglecting the female counterpart. One reason is because the majority of female do not participate in the labor market and focus on home production. Contrary to what is usually assumed in the literature, we model female endogenous participation choice and uncover their residual wage shock using an industry standard permanent and transitory wage model. We find that ignoring their participation decision would lead to a downward biased wage shock. Using our wage shocks estimate, we build a life cycle model to investigate the relationship between female labor force participation and family inequality. Through numerical simulation, we also shed lights on the insurance value provided by female labor supply in smoothing wage shocks. Our results suggest that although increase female labor force participation would lead to more inequality in a household level, female labor supply goes a long way in providing insurance value for smoothing wage shock.
The second chapter contains a succinct literature review of what we know and what do not know for the consumption smoothing and income shocks. In particular, we will review what theory, in particular, the life cycle permanent income hypothesis, has to say about the consumption response to different degree of income shocks. We will then discuss what will happen when we depart from the assumptions in the permanent income hypothesis. The degree of the consumption response to income shocks can help us to understand the interplay between consumption inequality and income inequality. In particular, it can provide us an identification strategy to figure out why and when does consumption inequality has to follow income inequality. Finally, we will discuss some open questions remained in the literature. We will see why income shocks may not be that permanent after all. More importantly, we will see why there is a great need for the research frontier to look for a parsimonious income process that can on one hand explains the empirical facts and on the other hand robust to alternative identification strategies.