Changes in durable stocks, portfolio allocation, and consumption expenditure in the aftermath of the Kobe earthquake

Abstract

To understand the household recovery process from unexpected serious damage caused by a natural disaster, we analyze household data from the Kobe earthquake in 1995. We address three questions—how damaged stocks of durable wealth are reinvested, how an ex post portfolio of borrowing or dissaving is reallocated to diversify the asset shocks caused by the disaster, and how formal and informal consumption insurance mechanisms are effective for amending home damage—all of which have been largely unanswered. We obtain three findings. First, people respond to negative income changes and housing damage by reinvesting damaged wealth. Second, households borrow extensively to amend the large housing damage caused by the earthquake. However, they dissave only for minor household asset damage. Third, consumption smoothing is not achieved for nondurable goods that are significantly affected by negative income changes and household asset damage. These findings suggest that asset shocks caused by a large natural disaster are not sufficiently diversified for households, indicating a large gap in designing effective insurance mechanisms.