Consumption Smoothing and Risk Coping Mechanisms: Evidence From Rural India

ABSTRACT Using monthly, seasonal and annual panel data from rural India from 2010 to 2014, we comprehensively analyze how households smooth consumption and adjust their asset portfolios in response to income shocks, identified by exogenous deviations of rainfall from historical patterns. First, we explore intra‐consumption adjustments and the role of household assets as a buffer stock. We find that, while households adjust their consumption basket from nonfood to food items in response to income shocks in the short term to smooth consumption, part or all of the income shock is passed through to consumption over the medium to long term. Second, we examine the differential roles of various household assets depending on the initial level of each asset based on a threshold model, and find that asset‐rich households tend to use a variety of assets, including machinery, capital assets, and livestock as a buffer stock, while asset‐poor households only rely on capital assets as a coping mechanism. Third, we estimate the relative roles of autarkic asset‐based strategies and informal village risk‐sharing, highlighting the importance of the latter. Our results support the hypothesis that informal risk‐sharing mechanisms are an important strategy for rural households to smooth consumption.