China Economic Quarterly International 2 (2022) 334–348

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China Economic Quarterly International

journal homepage: www.keaipublishing.com/en/journals/china-economic-quarterly-
international

Digital financial inclusion and household risk sharing: Evidence

from China's digital finance revolution☆
Xun Wang *, Xue Wang
Institute of Digital Finance, China Center for Economic Research, National School of Development, Peking University, No.5 Yiheyuan Road, Beijing,
China

A R T I C L E I N F O A B S T R A C T

JEL classification: This paper examines how digital finance development affects household risk sharing in China. We
D14 provide convincing evidence that households that experience idiosyncratic negative shocks on
G23 income growth exhibit a disproportionally lower level of reduction in idiosyncratic consumption
G51
growth in regions with better digital financial inclusion. Improved risk sharing through reduction
Keywords: in transaction costs of remittance that digital finance generates, and the liquidity and saving ef-
Household finance
fects that digital financial products provide are two possible mechanisms through which digital
Digital finance inclusion
financial inclusion affects household risk sharing. However, the development of traditional
Credit market
Risk sharing banking credit market does not appear to promote risk sharing.
Self insurance

1. Introduction

In theory, one of the main benefits of access to finance is that it provides better opportunities for households and individuals to share
risks in the face of idiosyncratic fluctuations in income growth. However, traditional financial institutions in developing countries are
usually less-developed, and more inclined to provide credit and other financial services to corporate sectors. Thus, self-insured measures
by accumulating precautionary savings and risk sharing mechanism through utilizing informal social networks, have provided
important informal means by which households and individuals partially insure themselves against risks. In this paper, we emphasize a
complementary source of strengthening and extending these informal methods: digital finance. We examine the effects of the devel-
opment of digital financial market on risk smoothing by analyzing a large panel household survey to provide some insights on the
revolution of digital finance in China.
Digital finance closely relates to the buzzword “Fintech”, that is, the innovative financial services or products delivered via digital
technology. Both digital finance and Fintech highlight how technology innovation empowers finance. The major difference between
them is that the concept of the former is broader and refers to digital financial services provided by financial as well as non-financial
institutions such as Fintech companies. In China's context, digital finance is defined in a narrow sense, as the digital services provided by
private Fintech companies (Chen, 2016), which is also the definition in this paper.
Digital finance, initiated by private Fintech companies such as Ant Financial and Tencent, is a recent innovation in China. One of the

☆
We appreciate insightful comments and suggestions from Lixing Li (the Editor) and two anonymous reviewers. We also would like to thank
Guowei Cai, Yiping Huang, Jingwen Yu, ShilinZheng for their valuable comments. The authors thank The National Social Science Fund of China (No.
18ZDA091) for their financial support.
* Corresponding author. National School of Development, Peking University, No.5 Yiheyuan Road, Haidian District, Beijing, China.
E-mail addresses: xunwang@nsd.pku.edu.cn (X. Wang), xwang2017@nsd.pku.edu.cn (X. Wang).

https://doi.org/10.1016/j.ceqi.2022.11.006
Received 5 November 2022; Received in revised form 22 November 2022; Accepted 23 November 2022
Available online 9 December 2022
2666-9331/© 2022 The Authors. Publishing services by Elsevier B.V. on behalf of KeAi Communications Co. Ltd. This is an open access article under
the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
X. Wang, X. Wang China Economic Quarterly International 2 (2022) 334–348

first and most successful practices to date is the mobile payment system. In just four years after the advent of Alipay and WeChat Pay in
2013, mobile payment had been adopted by over 70 percent of China's adult population, with 66.5 percent in rural areas. The rapid
adoption was in part due to the prevalence of smartphone and rapid development of Fintech in China. Unlike some mobile money (for
example M-PESA in Kenya and South Africa) in other developing economies which needs a network of agents to provide cash-in and
cash-out services, first, mobile payment in China has functioned as an E-wallet which provides a safe and remunerated saving vehicle,
payment could be easily implemented by scanning the QR code, and second, real time money transfers to others at almost zero cost have
already been available between accounts within the ecosystem.
The rapid development of digital finance in China helps households achieve better risk smoothing through at least two mechanisms.
First, improved risk sharing within the informal social networks due to reduced transaction costs of remittances. Since the WTO entry,
families and social networks in China have been dispersed over large distances due to internal migration, mainly from the central and
western regions to the eastern coastal areas. The migration has been largely motivated by employment and other opportunities. By the
end of 2018, there were still 288 million migrant workers in China, among which, over 60 percent left their home cities. Before the
advent of mobile payment system, most households delivered remittances through China Post or bank transfer. This traditional process
was relatively costly and time-consuming. One way of the predominant use of mobile payment in China has been, and continues to be
person to person transfers. When experiencing negative income shocks, individuals might receive real time transfers from parents,
relatives and friends through mobile payment system. Not only are the actual costs of the transfers lower, but the convenience and time
saving of the process mean substantial reductions in the costs of sending and receiving money. In this context, lower transaction cost
might have significant impacts on the frequency and size of the internal remittances, and hence the ability for individuals to smooth
risks.
Another characteristic of China's digital financial service is that it provides a safe and remunerated saving instrument which might
generate the liquidity and saving effects. Balances in Yu’E Bao, the largest online money market mutual fund in China provided by
Alipay, widely accepted from supermarkets to street vendors, has functioned as M1. The return rate on the balances in Yu’E Bao, is on
average 2 percent higher than that of time deposits in the bank. With the mobile payment system, households could probably build up
precautionary savings with high liquidity by investing in Internet money market mutual fund to enhance the capability of self-insurance
when suffering from household-specific income shocks.
To examine the effect of digital financial inclusion on household risk sharing, we combine index of digital financial inclusion at
prefecture city level developed by the Peking University with a large household panel survey data from China Household Finance Survey
(CHFS) conducted between 2013 and 2017. The strategy we pursue to identify household specific movements in consumption depends
on finding a differential response in household idiosyncratic consumption growth to shocks on idiosyncratic income growth according to
digital financial inclusion. Specifically, we identify the effects of digital financial inclusion by testing whether households that expe-
rience larger negative shocks on idiosyncratic income growth exhibit a disproportionately lower level reduction in idiosyncratic con-
sumption growth in regions with higher digital financial inclusion.
At the same time, we also include full sets of household fixed effects, time fixed effects, province-time fixed effects and rural-time
fixed effects to control for missing variables. We allow for all observable household characteristics and city level economic conditions to
affect risk sharing by controlling for their interactions with idiosyncratic household income growth. This allows us to control for the
correlations of digital finance with observable household and city level covariates that might help insure risks. In addition, we also
employ an IV approach to deal with potential missing variable concerns in the robustness checks.
With these various specifications, we find convincing evidence that digital financial inclusion has had a significant impact on the
ability of households to insure risks. Households who experience negative shocks on idiosyncratic income growth exhibit a dispro-
portionately lower level reduction in idiosyncratic consumption growth in regions with better developed digital financial market. We
identify the economic mechanisms through which the development of digital finance affects households risk sharing. We show that
these effects are not just attributable to the improved risk-sharing ability through the reduction in transaction costs of remittances that
digital finance provides, but also due to the liquidity and saving effects that digital finance generates. However, the development of
traditional banking credit market does not appear to promote households’ ability of sharing risks.
This paper is closely related to two strands of literature. One is the empirical macro study that analyzes financial factors that affect
the extent of international risk sharing. An extensive literature focuses predominantly on the impact of financial openness or capital
account liberalization and finds little evidence on improved households risk sharing globally despite the widespread financial inte-
gration and only industrial countries have attained better risk sharing during the period of globalization (Pakko, 1998; Kose et al., 2003,
2009; Sørensen et al., 2007; Bai and Zhang, 2012; Balli et al., 2013).
Besides, some studies turn to emphasize the role of improvement of domestic financial market. Asdrubali et al. (1996) quantifies the
extent of risk sharing among states in the United States and finds that 39 percent and 23 percent of the shocks of gross state products are
smoothed by domestic capital markets and credit markets. Li and Liu (2018) complement this strand of literature by looking into
intra-national determinants of pooling risk, and finds that domestic financial freedom plays an active role in promoting household risk
smoothing. Our paper differs from theirs by examining a household-level micro survey data and by focusing on the effects of specific
domestic financial forms, that is, the rapidly developed digital finance and at the same time, of the traditional banking credit market, on
household risk smoothing.
The other strand is the consumption insurance literature documenting the methods and extent to which households in developing
economies could insure themselves against risks. In developing and low-income countries, informal risk sharing through mechanisms
such as inter-household transfers, marriage, precautionary savings, state-contingent loan repayments and generation insurance scheme,
provide important means by which households insure risks (Rosenzweig and Stark, 1989; Udry, 1994; Townsend, 1994, 1995; Boes and
Siegmann, 2018; Niu et al., 2020). For individuals who suffer negative illness shocks, Gertler and Gruber (2002) and De Weerdt and

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Dercon (2006) observe that informal insurance helps to finance their expenditure needs. Although these findings provide evidence that
households engage in trades or arrangements to promote the ability of risk bearing, the insurance they provide is often incomplete. A
number of reasons for this incompleteness have been proposed, including the problem of moral hazard and limited commitments
(Thomas and Worrall, 1990; Ligon et al., 2002; Attanasio and Pavoni, 2011).
Despite intense academic and policy debates, few studies have incorporated the effect of the emerging financial service, namely,
digital finance, into the analysis of informal risk smoothing. Lower-income households are usually deprived of access to formal financial
services in developing countries where financial infrastructure and system are underdeveloped. As a complement to traditional financial
sector, digital finance, mostly motivated by big private technical companies in developing countries, to some extent expands households'
access to financial services including mobile payment, real time money transfers with lower cost, online saving and investment, financial
education and others through technological innovations (World Bank, 2014). One recent exception is that Jack and Suri (2014) which
studies the effects of expansion of Kenya's mobile money on risk sharing. Using data from a panel household survey, they highlight the
role of reduced transaction costs on risk sharing and find the expansion of mobile money facilitates remittances between individuals and
improve the ability of households to share risks. Dobridge Christine (2018) highlights the role of high-cost credit played in consumption
smoothing for households with limited access to other kinds of credit.
While transaction costs and remittances could be important for insurance network (Yang and Choi, 2007), the increased liquidity and
saving effects that digital finance provides could probably improve the ability of smoothing risks when household's idiosyncratic income
growth suffers from negative shocks. Hence, we add to this literature on two fronts. First, different from the studies that evaluate the
effects of household-level access to digital financial services, we identify the heterogeneous effects of emerging digital financial market
and traditional credit market on household risk smoothing, by incorporating municipal-level measures of digital finance and credit
market development with household survey data. Our results show that the emerging digital finance has functioned as an active
complement to traditional bank credit market, since digital finance significantly promotes the ability of smoothing risks, especially for
the low-income households. Second, we investigate the broader effects of digital finance on households' ability of risk bearing by
analyzing a large panel household survey data in China. Our analysis indicates that the impacts on household risk smoothing are not just
due to improved ability of risk sharing that the reduction in transaction costs of remittances that digital finance provides, but also due to
the liquidity and saving effects that digital finance products may provide.
The rest of this paper is structured as follows. In the next section we provide background information on the development of digital
finance in China. In section 3 we provide a description of our data and followed by a discussion of our empirical strategy in section 4. In
section 5, we present our results and we conclude in section 6.

2. Background on digital finance in China

Digital finance has been operating in China for more than 10 years since the advent of Alipay, a third-party mobile and online
payment platform established by Alibaba's Ant Financial Services Group in 2004. But most people regard the launch of Yu’E Bao, an
online money market fund on the platform of Alipay in June 2013 as the starting point from which the recent explosive development of
digital finance in China began. While the concept of Fintech was initially introduced in the United States, its development has been much
faster in China than that in most other countries in terms of breadth and depth.
In the field of mobile payment, Alipay and WeChat Pay in China, with market share of 53.8 percent and 38.9 percent in 2018
respectively, have been providing payment and transfer services to hundreds of millions of customers. Alipay alone had 870 million
active users by the end of 2018, over three times that of PayPal globally. Chinese payment providers not only cover more customers, but
also depend much more on mobile technology. Annual growth rate of mobile payment by banks and third-party providers reached 36.7
percent in 2018 (PBOC, 2018) which is far beyond the growth rate of payment transactions by PayPal. In the field of wealth man-
agement, more than 600 million accounts have invested in the online money market product Yu’E Bao in 2018, which has assets that
amount to more than US $160 billion. While the famous Wealth front has only 11.3 billion in assets under management. In the field of
financing, according to Alibaba's financial report in 2018, Ant Financial has issued more than 2000 billion RMB (or more than US$ 290
billion) to over 15 million small and medium enterprises (SMEs) by the end of 2018, with an average non-performing loan (NPL) ratio of
1.3 percent.
Besides favorable regulation environment, at least two factors help to explain China's rapid progress in Fintech development. First,
China enjoyed backward advantages because the inclusiveness of formal traditional financial sector is relatively low. China's economic
growth has long been driven by investment. Correspondingly, the traditional financial system dominated by state-owned banks is more
inclined to provide credit and other financial services to large enterprises and state-owned enterprises (SOEs), which leaves much room
for the development in the fields of payment, wealth management, insurance, financing, and credit rating for households and SMEs.
Financial access for all social classes in these areas is precisely one of the goals of financial inclusion, which is still much needed in China,
not only for the low-income individuals, but also for average financial consumers and SMEs.
Second, the integration of rapidly developing Fintech and real-life scenarios have been much better in China during this period. As
China's growth model transforms from investment-driven to consumption- and innovation-driven, providing better financial services to
households and SMEs becomes more needed and important. The leapfrogging of digital finance in China has been made possible with
the progress of digital technology that closely matches the financial needs of households and SMEs.
In China's Fintech industry, Alipay and WeChat Pay are now the two leading platforms. Using these payment tools, individuals can
make payment at par in most stores or vendors across the country, and transfer the balances to any other users in the country, even if the
recipient is not registered with the mobile payment system. Depositing funds in Alipay or WeChat Pay account and transferring across
accounts are free. Withdrawals are free within the amount of 20,000 RMB and the excess amount will be charged at a cost of 0.1 percent.

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As estimated, over 90 percent of residents in large cities of China use mobile payment as their primary payment method, with cash
second and debit/credit card third. And now, the mobile financial ecosystem in China not only provides mobile payment, real time
transfer and wealth management services, but also allows for online lending, credit rating and more, which will continuously reshape
China's financial structure.

3. Data and summary statistics

3.1. Household survey data

The household data for analysis in this paper is from 3 waves of the China Household Finance Survey (CHFS), conducted in 2013,
2015, and 2017. The CHFS is a household-level nationally comprehensive survey conducted via face-to-face interviews, based on a
standardized questionnaire. The questionnaire consists of four parts: demographics, financial assets and liabilities, insurance and social
security, and expenditure and income. The sample size was 28,000 households in 2013 and increased to 37,289 in 2015 and 40,011 in
2017. The randomly selected households come from 1397 villages and communities in 29 provincial administrative regions (Xinjiang,
Tibet, Hong Kong, Macao, and Taiwan are excluded).
The survey tracks households every two years, and adds new households into the sample in each follow-up survey. In our analysis, we
focus only on the change of consumption and income, so we difference the value of these variables between two rounds, thus the tracked
sample allows us to construct a two-period balanced panel of 14,580 effective households (29,160 household-year observations in total)
sample in this study. Within the sample, there are 8825 urban households accounting for 60.5 percent of total sampled households. It is
important to note that the survey was conducted in July of 2015 and 2017, and in fact it collected the financial information of
households in the previous year, i.e. 2014 and 2016. To calculate growth of household consumption and income, all the values are
converted into 2016 constant prices using consumer price index at prefecture-level cities.

Table 1
Summary Statistics
Variables 2014 2016

Obs Mean SD Obs Mean SD

Consumption per capita (yuan) 16,824 14722.76 13889.07 16,824 17114.97 14662.40
Income per capita (yuan) 16,824 18107.67 20286.79 16,824 23122.62 24761.72
Idiosyncratic consumption growth 16,819 0.04 0.84 16,823 0.03 0.80
Idiosyncratic income growth 15,850
0.02 1.36 16,289
0.15 1.51
Financial and economic development at city level:
Bank loan balance/GDP 162 0.97 0.58 162 1.15 0.66
GDP growth (percent) 162 8.36 3.14 162 7.08 3.47
Per capita expressway mileage (meter) 161 3.77 4.38 161 3.90 4.46
Per capita highway mileage (m2) 147 3.93 2.86 147 4.59 3.22
Digital finance development at city level
Digital Financial Index 162 145.90 20.25 162 196.62 21.46
Df-Breath of coverage 162 150.51 28.85 162 180.12 31.10
Df-Depth of usage 162 124.63 24.64 162 196.46 19.95
Df-Level of digitalization 162 169.35 38.21 162 251.38 23.27
Household demographics
Age of household head 16,824 53.86 13.33 16,824 55.40 13.16
Male ¼ 1 (for household head) 16,824 0.80 0.40 16,824 0.82 0.39
Employed ¼ 1 (for household head) 16,736 0.66 0.48 16,824 1.00 0.00
Number of family members whose highest education level is:
Primary/Family size 16,824 0.20 0.26 16,824 0.22 0.29
Middle/Family size 16,824 0.27 0.27 16,824 0.26 0.29
High/Family size 16,824 0.17 0.24 16,824 0.17 0.25
College/Family size 16,824 0.06 0.15 16,824 0.06 0.16
University/Family size 16,824 0.07 0.17 16,824 0.07 0.18
Number of family members whose age is:
younger than 16 & male/Family size 16,824 0.07 0.12 16,824 0.07 0.12
between 17 and 64 & male/Family size 16,824 0.34 0.21 16,824 0.32 0.23
between 17 and 64 & female/Family size 16,824 0.68 0.30 16,824 0.65 0.34
older than 65 & male/Family size 16,824 0.09 0.18 16,824 0.11 0.21
older than 65 & female/Family size 16,824 0.09 0.19 16,824 0.12 0.22
Financial and other instruments
Per capita asset
Social endowment insurance ¼ 1 if owns 16,824 250182.59 525139.63 16,824 345460.38 837354.00
Social medical insurance ¼ 1 if owns 16,824 0.57 0.33 16,824 0.69 0.33
Business insurance ¼ 1 if owns 16,824 0.80 0.29 16,824 0.92 0.22
Bankcard ¼ 1 if owns 16,824 0.07 0.19 16,824 0.07 0.21
Smartphone ¼ 1 if owns 16,824 0.35 0.48 16,824 0.51 0.50
Receive transfer ¼ 1 if yes 16,765 0.42 0.49 16,756 0.48 0.50
Internet wealth management ¼ 1 if owns 16,283 0.13 0.34 16,712 0.24 0.43
Current deposit ¼ 1 if owns 11,287 0.83 0.38 14,281 0.73 0.45

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3.2. Digital financial inclusion

The measure for development of digital finance comes from the Peking University Digital Financial Inclusion Index (PKU-DFII) of
China. Collaborating with Ant Financial Services Group of Alibaba, Peking University's Institute of Digital Finance develops this index to
make a systematic measure of digital finance in China during 2011–2018, based on customers' and users' big data and the method of
financial inclusion index proposed by World Bank and related literature. This index measures at three levels, national level, provincial
level and prefecture city level from three dimensions – breadth of coverage, depth of usage and level of digitization (Guo et al., 2020).
The breadth of digital financial coverage is an evaluation of the population covered by digital finance, which is measured by the
digital account coverage rate. The depth of digital finance usage measures the frequency of actual use of digital financial services,
including six sub-dimensions, namely, payments, money funds, credit, insurance, investment and credit investigation. The number of
actual users, the number of transactions per capita and the amount of transaction per capita for each sub-dimension are used to measure
the actual usage of the above services. As for the level of digitization, it reflects the convenience and cost of digital financial inclusion in a
region, which includes four sub-dimensions: mobility, affordability, Check Later consumer credit service and convenience. The more
convenient (such as greater liquidity) and cheaper the digital financial services (such as lower interest rates of loan initiated by Fintech
companies) are, the higher the level of digitalization, and vice versa.
More specifically, the PKU-DFII is constructed from bottom to top layer by layer using the 33 dimensionless indicators in total, and
the weights are determined by Analytic Hierarchy Process (AHP) analysis and coefficient of variation (CV) weighting method. First, the
CV method is used when calculating the weights of each specific indicator. Then, the AHP method is applied to calculate the weights for
each sub-dimension that are used to calculate the breadth of coverage, the depth of usage and the level of digitalization. Finally, the
PKU-DFII Index is aggregated using above three first-level dimensions whose weights are determined by AHP again.
As our sample collected information of households in 2014 and 2016, we use the digital financial inclusion Index in these two years,
accordingly. The data shows a great development of digital financial inclusion in China from 2014 to 2016. The median of the digital
financial inclusion index at municipality-level was 139.53 in 2014, and grew to 190.94 in 2016, indicating an 18.42 percent annual
growth. And the median of the breath of coverage, the depth of usage and the level of digitalization of digital finance services expe-
rienced 10.59 percent, 29.85 percent and 30.82 percent of annual growth, respectively.

3.3. Summary statistics

Table 1 reports summary statistics of the sample for analysis. Annual average per capita consumption rose from 14,723 yuan to
17,115 yuan during 2014–2016, and income per capita increased from 18,108 yuan to 23,123 yuan during the same period, indicating
that income per capita grew faster than consumption. And the standard deviation of idiosyncratic income growth is larger than that of
idiosyncratic consumption growth, which also implies that consumption is much smoother than income. The mean of loan balance of
traditional financial institutions and of the index of digital finance both increased during the two rounds survey, although the magnitude
cannot be compared in absolute level, digital finance appears to have experienced a greater growth of 34.4 percent.
Table 1 also presents a brief summary for households’ access to financial services and social security system. 68 percent of the
households reported having at least one bank account in the 2015 survey, the proportion increased to 90 percent in the 2017 survey. The
summary data shows that along with the development of digital finance, the proportion of households reported receiving transfer in-
come increased by 6 percent, and households having Internet investment and wealth management products (WMP) increased by 11
percent, while the proportion of having current deposits in traditional financial institutions experienced a decline of 10 percent. The
summary may lead us to an intuition that the development of digital financial inclusion might help to promote transfers among
households and savings in Internet WMP, however this relationship needs to be examined more carefully.

4. Empirical framework

4.1. Basic specification

Conventional theory of risk smoothing suggests that risk-averse households attempt to smooth their consumption growth in response
to variations in income growth due to unexpected shocks. In standard intertemporal models with complete markets, perfect insurance
implies the growth rates of marginal utility of consumption are equal across households. By assuming isoelastic utility function followed
by Kose et al. (2009), we can arrive at a basic equation for risk smoothing:


E Δlog Cijt
Δlog Ct Н ijt ¼ 0 (1)

where Cijt denotes annual per capita consumption for household i in city j at period t, Ct is the per capita national aggregate con-
sumption, and Н ijt represents the information set specific to household i in city j at period t. This yields the following regression
specification:

Δlog Cijt
Δlog C t ¼ θН ijt þ εijt (2)

If the marginal utility of per capita consumption is independent of income shocks, and the unexpected fluctuations in income is the
unique source of uncertainty, then full insurance is reflected in fully smoothed marginal utility of consumption across states and

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individuals, which implies the following basic risk smoothing equation:

Δlog Cijt
Δlog C t ¼ αi þ β Δlog Yijt
Δlog Y t þ εijt (3)

where Y t is the per capita national aggregate household income. Growth rates of Ct and Y t are measures of common (aggregate)
fluctuations in household consumption and income. Under capital account restrictions, common systemic national risks cannot be
eliminated by risk sharing across households, the aggregate component of each variable is subtracted from the corresponding household
variable. Following Sørensen et al. (2007), the deviation of the growth from its common component of each variable captures idio-
syncratic household-specific fluctuation in that variable.
The coefficient β captures the average level of co-movement between the idiosyncratic consumption growth and income growth
across households. In a model of full insurance and complete domestic financial market, β is supposed to equal to zero. In this sense, β
can be used to measure the degree of risk sharing (Asdrubali et al., 1996), as the smaller β indicates the greater degree of risk sharing
across households.
This regression specification is also used to examine the roles that financial integration and/or domestic financial liberalization
played in international risk sharing across countries. By allowing β vary over time, one could capture the evolution of risk sharing for
countries in different income levels. Similar patterns are revealed in this literature that industrial countries have attained better risk
sharing during recent globalization period, whereas risk sharing in developing countries, including emerging markets, does not seem to
be promoted in the process of globalization. While financial integration has exhibited limited role in international risk sharing (Kose
et al., 2009; Kim, 2014), domestic financial liberalization does serve as a critical factor that determines a country's ability to share
idiosyncratic consumption risks (Li and Liu, 2018).
In this paper, we focus on domestic financial markets improvements and identify their effects on the ability of household risk
bearing. We use a simple fixed-effects strategy to investigate and compare the impacts of digital finance development and traditional
banking credit on risk smoothing in China by examining their roles in affecting the sensitivity of idiosyncratic consumption growth to
idiosyncratic income growth in the following specification, which closely follows Kose et al. (2009), Jack and Suri (2014), Li and Liu
(2018) among others:


~ ijt ¼ β1 Δlog Y
Δlog C ~ ijt þ β2 log DFjt  Δlog Y
~ ijt þ γXijt þ αi þ ηt þ π pt þ ωrt þ εijt (4)

where for simplicity, we set Δlog C ~ ijt ¼ Δlog Cijt
Δlog Ct ; Δlog Y
~ ijt ¼ Δlog Yijt
Δlog Y t ; αi is household fixed effect, ηt is time fixed
effect, π pt are a set of province-by-time dummies, ωrt are a set of rural-by-time dummies, logDFjt is the log of the digital financial inclusion
in city j in period t, and Xijt is a vector of household-level and city-level controls. Specifically, household level controls includes
household demographics, household per capita assets, years of schooling, age and gender of household head, smart phone ownership,
the use of financial instruments including bank account, social insurance, and business insurance, and occupation dummies; prefecture
city level controls include log of the digital financial inclusion, log of bank credit over GDP (logBC), real GDP growth, industrial
structure, per capita expressway mileage and per capita highway mileage to control for local economic conditions. The π pt in Equation
(4) are included to control for aggregate province-level shocks and the ωrt are to control for different trends in urban and rural areas. The
estimation results show that these region-by-time and rural-by-time dummies have little impact on our base results.
In this specification, γ is the coefficient vector of interest. The degree of risk sharing across households is captured by (1
β1

β2 log DFjt ). If households can fully insure themselves in the face of idiosyncratic income growth shocks, then β1 þ β2 log DFjt should
equal to zero. When any element of the coefficient vector of interest, β2 , is negative, then we might claim that digital financial inclusion
promote the degree of the risk sharing achieved by households and vice versa.

4.2. Identification

Reverse causality concern about our econometric framework is low because idiosyncratic household-specific fluctuations in con-
sumption growth is unlikely to drive digital financial inclusion at more aggregate city level. Furthermore, we are not focusing on the
causal effects of digital financial inclusion on consumption growth, but on the effects of digital financial inclusion on the sensitivity of
household idiosyncratic consumption growth to household idiosyncratic income growth. However, a challenge with identifying the
effect of digital financial development on household risk sharing is that omitted determinants of households’ idiosyncratic consumption
growth may bias the estimations. To deal with this, we include fixed effects by exploiting the panel structure of our sample to control for
other sources of missing variables.
Since digital financial inclusion in a specific region is correlated with the households’ adoption of digital financial instruments in this
region, digital financial inclusion may be correlated with education, occupation, the use of other finance instruments and other
household characteristics, which might help households smooth risk. This means that the coefficient on digital finance cannot be
necessarily interpreted as capturing the impact of digital finance itself on risk smoothing. Thus, we extend our baseline equation to
include the interactions of idiosyncratic income growth with all observed covariates:



~ ijt ¼ β1 Δlog Y
Δlog C ~ ijt þ β2 log DFjt  Δlog Y
~ ijt þ γ 1 Xijt  Δlog Y
~ ijt þ γ 2 Xijt þ αi þ ηt þ π pt þ ωrt þ εijt (5)

Using this strategy, we can also identify the mechanisms through which digital financial inclusion in China helps households smooth
their risks, in particular the roles of remittances and precautionary savings, by estimating the following equations:

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~ ijt þ β2 log DFjt  Δlog Y
Rijt ¼ β1 Δlog Y ~ ijt þ γ 1 Xijt  Δlog Y
~ ijt þ γ 2 Xijt þ αi þ ηt þ π pt þ ωrt þ εijt (6)

~ ijt þ β2 log DFjt  Δlog Y
Sijt ¼ β1 Δlog Y ~ ijt þ γ 1 Xijt  Δlog Y
~ ijt þ γ 2 Xijt þ αi þ ηt þ π pt þ ωrt þ εijt (7)

In Equation (6), Rijt is a measure of remittances, either a dummy of receiving transfers from parents, or receiving transfers from
relatives and friends. Again, the coefficient of interest is γ ; . A negative coefficient in γ ; indicates that the probability of receiving transfers
increased for household i with the increase in the degree of digital finance development in city j, in case of experiencing a decline in
idiosyncratic income growth. In Equation (7), Sijt is a measure of household saving, either the probability of investing in online wealth
management products provided by Fintech companies or the probability to save in a traditional banking account.

5. Empirical results

In this section, we present the estimation results from the empirical strategies above, including analysis on mechanisms. Our results
show increased inclusiveness contributed by digital finance do promote the ability of households, especially the poor, to bear risks.
Mechanism analysis indicates that this is not just attributable to the improved risk sharing through reduction in transaction costs that
digital finance provides, but also due to the liquidity and saving effects that digital finance may generate. However, the development of
traditional credit market does not appear to promote household risk smoothing.

5.1. Baseline Results

Table 2 presents the results of our basic specifications. Column 1 in Table 2 reports the results of panel regressions with no controls
except time fixed effect and household fixed effect. The coefficients on Δlog Y ~ and the interested interaction term logDFΔlog Y ~ are
~
significant with expected signs. The positive sign on Δlog Y shows that household idiosyncratic consumption growth in China, to a large
extend, still depends on household income growth. The negative sign on the interaction term logDFΔlog Y ~ shows preliminary evidence
that the development of digital finance helps households reduce the co-movement between the household-specific fluctuations in
consumption and income growth, which indicates that digital finance might play a positive role in households consumption risk
smoothing. In other words, this result indicates that households who experience negative income shocks exhibit a disproportionally
lower level of reduction in idiosyncratic consumption growth in regions with better developed digital finance. While the development of
traditional finance, measured by the logarithm of the ratio of bank credit to GDP at city level, seems to have a contrary effect on risk
sharing compared with digital finance, the effect is not statistically significant. It is plausible that the traditional financial institutions are
more inclined to provide financial services to the corporate sector by repressing household consumption (Lardy, 2008).
In column 2 we include household level controls and city level controls, and we further add the interactions of these controls with the
household idiosyncratic income growth in column 3. The results are quite similar, households in a municipal administrative region with
relatively higher level of digital financial inclusion appear to be more enabled to smooth their idiosyncratic consumption growth. We
further include rural-by-time dummies and province-by-time dummies in columns 4 and 5. The coefficient estimates presented in
column 5 correspond to the complete specification of Equation (5), where we include the household fixed effects, the time effects and

Table 2
Digital Finance and Household Risk Smoothing: Baseline Results
~
Dependent Variable: Δlog C

(1) (2) (3) (4) (5)

~
Δlog Y 0.849*** 0.678** 0.632** 0.659** 0.662**
(0.285) (0.285) (0.291) (0.291) (0.291)
~
logDF  Δlog Y
0.147***
0.114**
0.150***
0.155***
0.156***
(0.055) (0.055) (0.057) (0.057) (0.057)
~
logBC  Δlog Y 0.027 0.019 0.019 0.019 0.019
(0.017) (0.017) (0.018) (0.018) (0.018)
Household & No Yes Yes Yes Yes
City level Controls
Controls Interactions No No Yes Yes Yes
HH FE; Time FE Yes Yes Yes Yes Yes
Rural  Time FE No No No Yes Yes
Province  Time FE No No No No Yes
Observations 31,694 29,160 29,160 29,160 29,160
R-squared 0.30 0.33 0.33 0.33 0.33

Note: this table reports the results of baseline regressions in which the dependent variable is household idiosyncratic per capita consumption growth,
~ Δlog Y
Δlog C. ~ denotes the household idiosyncratic per capita income growth. Controls: household level controls: household demographics, household
per capita assets, household head years of schooling, age, gender, smart phone ownership, the use of financial instruments including bank account,
social insurance, and business insurance, and occupation dummies; city level controls: log of the digital finance index (logDF), log of the ratio of bank
credit to GDP (logBC), real GDP growth, industrial structure, per capita expressway mileage, per capita highway mileage. Control interactions: in-
~ Robust standard errors clustered at the household level are reported in the reported in the parentheses. ***P < 0.01,
teractions of controls with Δlog Y.
**P < 0.05, *P < 0.1.

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time-varying rural and region effects. The coefficient on the interaction with digital finance is always negatively significant and rela-
tively robust even in the most restricted specification in column 5. Based on the magnitudes of the coefficient estimates reported in
column 5, when suffering from a one percentage point decline in idiosyncratic household per capita income growth, the idiosyncratic
household per capita consumption growth is 5.79 percentage points (¼0.188  0.308) higher in a prefecture level city with digital
finance market development at the 75th percentile (5.257) compared with a prefecture level city with digital finance market devel-
opment at the 25th percentile (4.949). This number is economically large, given that the sample average of idiosyncratic household per
capita consumption growth is 3.5 percent. These results indicate that a mitigating effect of digital financial development: better-
developed digital finance tends to significantly enhance the ability of the households to insure against income growth shocks.

5.2. Heterogeneity analysis

5.2.1. Urban-rural division and different regions

We examine the effects of digital financial inclusion on household risk smoothing among different sub-samples according to urban-
rural division and geographical locations in Table 3. In the long standing urban-rural binary economic system in China, households
living in rural areas are underserved by traditional banking sector and have limited access to financial services. Columns 1 and 2 of
Table 3 report the estimation results based on urban-rural division. Economically sizable and statistically significant relationship be-
tween digital finance and risk smoothing are revealed in both samples, but with a much larger effect in magnitude for rural households.
Overall, we find that the mitigating effect of digital finance are more pronounced for households with income below median-level and in
rural areas, those households are generally considered to be underserved by banking sector and have limited access to financial services
previously. Again, we find no supportive evidence for such mitigating effect from traditional credit market.
As known, economic performance is significantly different across regions in China. Thus, we further divide the sample into three
subsamples in column 3 to 5, namely, eastern, central and western regions according to the classification by National Bureau of Statistics
of China. Estimation results indicate that the impact of digital finance on household risk smoothing are significant for households in
more-developed eastern and central provinces, but is not statistically significant for households in less-developed western areas. These
results are consistent with the international risk sharing literature which shows that risk sharing outcomes only happen in developed
countries, while less-developed countries have not yet obtained this benefit during the period of globalization since 1980s (Kose et al.,
2009; Bai and Zhang, 2012; Li and Liu, 2018). The insignificance in Western provinces may indicate that although the gaps between the
western regions and the central and eastern regions have been narrowed rapidly in recent years as shown by Digital Financial Inclusion
Index, rooms still leave for western region in improving the digital financial development in order to enjoy the beneficial effect of risk
smoothing. It is worth noting that compared to the eastern regions, both the significance and the magnitude of the coefficient estimates
on digital finance are more pronounced in central regions. These results suggest that in regions that exceed the threshold conditions that
cause digital finance exhibit significant risk smoothing effects, the marginal effects are much larger in the less developed regions.

Table 3
Heterogeneity analysis: urban & rural, and different regions
~
Dependent Variable: Δlog C

Urban Rural East Middle West

(1) (2) (3) (4) (5)

~
Δlog Y 0.666** 1.092*** 0.622 1.510*** 0.123
(0.317) (0.380) (0.404) (0.421) (0.538)
~
logDF  Δlog Y
0.140**
0.243***
0.136*
0.358***
0.025
(0.064) (0.075) (0.079) (0.086) (0.106)
~
logBC  Δlog Y 0.013 0.004 0.029
0.002 0.014
(0.015) (0.022) (0.021) (0.028) (0.029)
Household & Yes Yes Yes Yes Yes
City level Controls
Controls Interactions Yes Yes Yes Yes Yes
HH FE; Time FE Yes Yes Yes Yes Yes
Rural  Time FE No No Yes Yes Yes
Province  Time FE Yes Yes Yes Yes Yes
Observations 17,650 11,510 12,406 10,432 6322
R-squared 0.33 0.33 0.35 0.33 0.36

Note: this table examines the heterogeneous effects of digital financial inclusion among urban and rural areas and across different regions. The
dependent variable is household idiosyncratic per capita consumption growth. Δlog Y ~ denotes the household idiosyncratic per capita income growth.
Controls: household level controls: household demographics, household per capita assets, household head years of schooling, age, gender, smart phone
ownership, the use of financial instruments including bank account, social insurance, and business insurance, and occupation dummies; city level
controls: log of the digital finance index (logDF), log of the ratio of bank credit to GDP (logBC), real GDP growth, industrial structure, per capita
~ Robust standard errors clustered at the
expressway mileage, per capita highway mileage. Control interactions: interactions of controls with Δlog Y.
household level are reported in the reported in the parentheses. ***P < 0.01, **P < 0.05, *P < 0.1.

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Table 4
Heterogeneity analysis: different income levels
High Income Households Low Income Households

All Food Nonfood All Food Nonfood

(1) (2) (3) (4) (5) (6)

~
Δlog Y 0.456 0.803 0.586 1.131*** 1.349*** 1.228***
(0.423) (0.583) (0.546) (0.317) (0.508) (0.404)
~
logDF  Δlog Y
0.105
0.097
0.147
0.236***
0.287***
0.243***
(0.083) (0111) (0.107) (0.064) (0.103) (0.081)
~
logBC  Δlog Y 0.010
0.003 0.036
0.002 0.036
0.014
(0.022) (0.028) (0.030) (0.017) (0.026) (0.023)
Demographic & Yes Yes Yes Yes Yes Yes
Other Controls
Controls Interactions Yes Yes Yes Yes Yes Yes
HH FE Yes Yes Yes Yes Yes Yes
Time FE Yes Yes Yes Yes Yes Yes
Rural  Time FE Yes Yes Yes Yes Yes Yes
Province  Time FE Yes Yes Yes Yes Yes Yes
Observations 15,648 15,648 15,648 13,512 13,512 13,512
R-squared 0.32 0.28 0.31 0.35 0.26 0.34

Notes: this table examines the heterogeneous effects of digital financial inclusion among households with difference income levels. The dependent
variable is household idiosyncratic per capita consumption growth. Δlog Y ~ denotes the household idiosyncratic per capita income growth. Controls:
household level controls: household demographics, household per capita assets, household head years of schooling, age, gender, smart phone
ownership, the use of financial instruments including bank account, social insurance, and business insurance, and occupation dummies; city level
controls: log of the digital finance index (logDF), log of the ratio of bank credit to GDP (logBC), real GDP growth, industrial structure, per capita
~ Robust standard errors clustered at the
expressway mileage, per capita highway mileage. Control interactions: interactions of controls with Δlog Y.
household level are reported in the reported in the parentheses. ***P < 0.01, **P < 0.05, *P < 0.1.

5.2.2. Different income levels

In Table 3, we split the whole sample into two groups: high income and low income according to their income in the 2015 survey. We
consider households “high income ones if their income in 2015 is above the median value across households. Estimation shows that the
coefficient on logDFΔlog Y ~ is negative but insignificant for high-income households but is negative and significant for lower-income
sample at the 1 percent significance level. The size effect of digital finance on risk smoothing for higher-income sample is also
tremendously smaller than that for lower-income sample, indicating that the beneficial effects are mainly concentrated among poor

Table 5
Decomposition of the Digital Financial Inclusion index
~
Dependent Variable: Δlog C

First dimension Second-tier dimension index

BD DP DG MP OI MF IV CR

(1) (2) (3) (4) (5) (6) (7) (8)

~
Δlog Y 0.418* 0.509*** 0.718*** 0.371** 0.506* 0.461*** 0.232** 0.279**
(0.249) (0.164) (0.190) (0.154) (0.284) (0.172) (0.092) (0.117)
~
logDF  Δlog Y
0.097**
0.121***
0.153***
0.089***
0.100**
0.106***
0.076***
0.077***
(0.049) (0.032) (0.036) (0.029) (0.049) (0.032) (0.016) (0.022)
~
logBC  Δlog Y 0.005
0.001
0.007 0.001
0.001
0.001
0.003
0.005
(0.014) (0.012) (0.012) (0.013) (0.013) (0.013) (0.012) (0.012)
Household & City level controls Yes Yes Yes Yes Yes Yes Yes Yes
Control Interactions Yes Yes Yes Yes Yes Yes Yes Yes
HH FE; Time FE Yes Yes Yes Yes Yes Yes Yes Yes
Rural  Time FE Yes Yes Yes Yes Yes Yes Yes Yes
Province  Time FE Yes Yes Yes Yes Yes Yes Yes Yes
Observations 29,160 29,160 29,160 29,160 29,160 29,160 29,160 29,160
R-squared 0.33 0.34 0.33 0.33 0.33 0.34 0.34 0.33

Notes: this table examines the effects of digital financial inclusion at different dimensions. The first dimension includes the measures for Breadth (BD),
Depth (DP) and Digitalization (DG). And the second tier indicators include the measures for mobile payment (MP), online insurance (OI), monetary
funds (MF), online investment (IV) and online credit (CR). The dependent variable is household idiosyncratic per capita consumption growth. Δlog Y ~
denotes the household idiosyncratic per capita income growth. Controls: household level controls: household demographics, household per capita
assets, household head years of schooling, age, gender, smart phone ownership, the use of financial instruments including bank account, social in-
surance, and business insurance, and occupation dummies; city level controls: log of the digital finance index (logDF), log of the ratio of bank credit to
GDP (logBC), real GDP growth, industrial structure, per capita expressway mileage, per capita highway mileage. Control interactions: interactions of
~ Robust standard errors clustered at the household level are reported in the reported in the parentheses. ***P < 0.01, **P < 0.05,
controls with Δlog Y.
*P < 0.1.

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households. Negative but Insignificant effects for high income groups and negative and significant effects for low income groups still
hold when we further classify consumption into food consumption and non-food consumption. In accordance with Townsend (1995)
and Jack and Suri (2014), rich households are usually expected to have better access to formal finance and other resources, which
implies that they could smooth shocks effectively even without the availability of digital finance.

5.3. Sensitivity analysis

We conduct several sensitivity analyses. First, we test whether the findings are robust if we use sub-index of digital financial in-
clusion. In Table 5, we show results for the estimation effects of sub-indexes measuring different dimensions of digital financial in-
clusion. As described above, the index of digital financial inclusion is a weighted average from three dimensions: breadth of coverage,
depth of usage and level of digitization. We then examine the risk smoothing effect of digital financial inclusion from these three di-
mensions when facing a drop in idiosyncratic income growth, respectively. Results in column 1 through 3 of Table 5 indicate that breath
of coverage, depth of usage and the level of digitization all play a significant role in household risk smoothing, with the level of
digitization having the largest effects on risk smoothing.
By the definition of the level of digitization, it measures the convenience and cost for households accessing digital finance, which
truly reflects the virtue of low cost and low threshold of digital financial services. The significant role of the level of digitalization on
household risk smoothing reflects the importance of mobility, convenience and affordability for accessing digital financial services.
Furthermore, the depth of usage in PKU-DFII index contains 6 sub-dimensions, such as credit, investment, insurance etc. To save space,
we report results only for the item that is significant. Interestingly, the results in column 4 though 8 in Table 5 show that having easier
access to mobile payment, online insurance, monetary funds, online investment and credit helps to smooth household idiosyncratic
consumption growth.
Second, since the digital financial inclusion is measured at the prefecture city levels, we test whether the results are remained when
we cluster the standard error at city level to allow for correlations between observations within the same city group in Table 6. As
practiced before, we divide the sample according to urban-rural division in column 2–3 and high-low income division in column 4–5.
Although the results show that the significance on logDFΔlog Y ~ is declined, the coefficient estimates on logDFΔlog Y~ are still negative
and significant at 10% level, and the risk sharing effects are mainly concentrated in rural households and low income households.
Third, as we argued before, although the reverse causality concern is relatively low since household level consumption is less likely
to affect more aggregate city level digital financial inclusion, we run IV regression to further deal with the potential problem of missing
variables. Inspired by Jack and Suri (2014), we construct a distance to communication network as instrument for the digital financial
inclusion at city level. Note that the widespread of digital financial services cannot be realized without the extensive coverage of optical
fiber communication network which promotes quick speed and stable network connection. National Optical Trunk Fiber System
(NOTFS), known as the “eight horizontal main lines and eight vertical main lines (8-8)” and conducted by China National Planning
Commission and the Ministry of Posts and Telecommunications, was built during 1986–2000 to create a large-capacity, high-speed and
long-distance information transmission network spanning the entire country.
Specifically, we calculate two distance variables, the logarithm of the minimum geometric distance from the household city to the

Table 6
Clustering standard errors at city level
~
Dependent Variable: Δlog C

All Sample Low Income High income Urban Rural

(1) (2) (3) (4) (5)

~
Δlog Y 0.856 0.666 1.084* 0.468 1.071*
(0.543) (0.480) (0.624) (0.706) (0.589)
~
logDF  Δlog Y
0.188*
0.140
0.241**
0.107
0.225*
(0.107) (0.096) (0.118) (0.136) (0.116)
~
logBC  Δlog Y 0.008 0.013 0.004 0.009
0.003
(0.014) (0.013) (0.023) (0.025) (0.020)
Household & Yes Yes Yes Yes Yes
City level Controls
Controls Interactions Yes Yes Yes No Yes
HH FE; Time FE Yes Yes Yes Yes Yes
Rural  Time FE Yes Yes Yes No No
Province  Time FE Yes Yes Yes Yes Yes
Observations 29,160 17,650 11,510 15,648 13,512
R-squared 0.33 0.33 0.35 0.32 0.35

~ Δlog Y
Note: this table reports the regression results in which the dependent variable is household idiosyncratic per capita consumption growth, Δlog C. ~
denotes the household idiosyncratic per capita income growth. Controls: household level controls: household demographics, household per capita
assets, household head years of schooling, age, gender, smart phone ownership, the use of financial instruments including bank account, social in-
surance, and business insurance, and occupation dummies; city level controls: log of the digital finance index (logDF), log of the ratio of bank credit to
GDP (logBC), real GDP growth, industrial structure, per capita expressway mileage, per capita highway mileage. Control interactions: interactions of
~ Robust standard errors clustered at the city level are reported in the reported in the parentheses. ***P < 0.01, **P < 0.05, *P <
controls with Δlog Y.
0.1.

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NOTFS network, and the logarithm of the minimum geometric distance from the household city to the city alongside the NOTFS
network. These distance measures take into account factors like rivers, lakes, mountain ranges which could be considered exogenous.
We also control the city level economic conditions including GDP growth, infrastructure construction and industry structure to avoid the
distance variables working as proxies for local economic conditions. Since the advent of Yu E'Bao in 2014 by Ant Financial is usually
viewed as starting point of the takeoff of China's digital finance (Huang and Huang, 2018), we further construct an interaction term
between the logarithm of the distance and a time dummy which equals one after 2014 to capture the changing effect of the access to the
NOTFS network.
The results are presented in Table 7. We control for the baseline controls as above throughout this table. Columns 1 and 2 report the
results using the first distance variable as the instrument. Column 1 reports the first stage estimation results and column 2 reports the
second stage results. The Kleibergen-Paap rk F statistic is 567.36, implying that this instrument is not weak. The p-value of Kleibergen-
Paap rk LM statistic indicate that the null hypothesis of under-identification is rejected. Columns 3–4 report the corresponding results
using the second distance variable as the instrument. Consistent with the tests in column 1 and 2, the second distance variable seems not
weak either. Again, we find a negative and significant effects on digital financial inclusion on household risk sharing.
To sum up, compared with traditional banking sector, better digital financial inclusion is more conducive to intra-national risk
sharing. In most cases, it is not the lack of banking credit but the poor quality and inclusion of the traditional financial institutions that
hold up households from achieving effective consumption smoothing. Therefore, as an important complement, developing countries
should strengthen institutional development to make better use of the emerging digital finance.

5.4. Mechanisms

We find evidence that digital financial inclusion does have a significant effect on household risk sharing both statistically and
economically. Furthermore, it is important to examine the potential mechanisms through which the access to digital finance helps
households insure against idiosyncratic income shocks. We then try to provide preliminary evidence on two potential mechanisms:
improved risk sharing by reduction in transaction costs of online money transfers that digital financial platforms provide, and liquidity

Table 7
IV Results
Dependent Variable:
~
logDF  Δlog Y ~
Δlog C ~
logDF  Δlog Y ~
Δlog C

First Stage Second First Stage Second

(1) (2) (3) (4)

~
Δlog Y 5.230*** 1.249*** 5.138*** 1.243***
(0.029) (0.304) (0.030) (0.309)
~
logDF  Δlog Y
0.269***
0.267***
(0.062) (0.063)
~
logBC  Δlog Y 0.069*** 0.015 0.074*** 0.015
(0.004) (0.013) (0.004) (0.013)
~
logDist1  Δlog Y
0.031***
(0.002)
~  Post14
logDist1  Δlog Y 0.026***
(0.0003)
~
logDist2  Δlog Y
0.024***
(0.002)
~  Post14
logDist2  Δlog Y 0.025***
(0.0003)
Household Level & Yes Yes Yes Yes
City Level Controls
Controls Interactions Yes Yes Yes Yes
HH FE, Time FE Yes Yes Yes Yes
Rural  Time FE Yes Yes Yes Yes
Province  Time FE Yes Yes Yes Yes
Observations 29,160 29,160 29,160 29,160
Kleibergen-Paap rk F statistic 567.36 539.74
Kleibergen-Paap rk 0.00 0.00
LM statistic (P Value)

~ denotes the household idiosyncratic per capita income growth. Column 1 and 3 report the results
Note: This table reports results of IV regression. Δlog Y
of the first stage regressions. Column 2 and 4 report the second stage IV results. logDist1 refers to the log of the minimum distance between the city and
the NOTFS, and logDist2 is the log of the minimum distance between the household city and the city along the NOTFS. Controls: household level
controls: household demographics, household per capita assets, household head years of schooling, age, gender, smart phone ownership, the use of
financial instruments including bank account, social insurance, and business insurance, and occupation dummies; city level controls: log of the digital
finance index (logDF), log of the ratio of bank credit to GDP (logBC), real GDP growth, industrial structure, per capita expressway mileage, per capita
highway mileage. Control interactions: interactions of controls with Δlog Y.~ Robust standard errors clustered at the household level are reported in the
reported in the parentheses. ***P < 0.01, **P < 0.05, *P < 0.1.

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and saving effects generated by Fintech platforms. It is important to address that other mechanisms may also work, for example,
facilitating online borrowing, promoting the online insurance market, etc. Unfortunately, we could not verify these mechanisms yet due
to the data availability.

5.4.1. Reducing transaction cost

One of the notable achievements of China's digital financial practice is the mobile payment system. Mobile payments connect in-
dividuals in a broader economy and can strengthen informal insurance networks by accessing money or support from a community
wider than those physically proximate (Jack and Suri, 2014), thus help households share idiosyncratic risks. We then estimate the
possibility to receive money transfers when facing negative income shocks by using dummies indicating whether households received
money transfers from parents or parents in law, and from friends and relatives as dependent variables, respectively.
In column 1 and 2 of Table 8, we examine the response of purchasing power transfer to income shocks. The dependent variable is
whether the household receives remittance or not. The relevant interaction term is negative and significant in column 1 and 2, indicating
that with improved digital financial inclusion, households in regions with better developed digital finance receive more transfer income
in terms of the probability of receipt when suffering from negative income shocks. In column 3 and 4, we further exclude government
transfers by collecting whether household receives remittances from non-government parties including parent, other relatives or friends.
Estimation estimates on logDFΔlog Y ~ almost remain the same.

5.4.2. Liquidity and saving effect

Next, we investigate the risk sharing effect of digital finance through the liquidity and saving effect generated by holding Internet
financial products. The dependent variable in columns 1 through 3 of Table 9 is again a dummy, indicating whether households holding
Internet wealth management products (WMPs) or not, and we find significant evidence on the risk smoothing impact of digital finance
through owning Internet WMP (Appendix A provides details about the construction of the dependent variable). The relevant interaction
term is positive and significant at 1 percent level, indicating that with improved digital financial development, households will increase
investment/saving in online WMP products provided by the Fintech companies, for example Yu’E Bao, in terms of the probability of
holding to build up precautionary savings when experiencing increase in idiosyncratic per capita income growth, while households will
reduce the savings in terms of the probability of holding to insure themselves against risks when suffering from a reduction in idio-
syncratic income growth. A plausible explanation is that households have access to digital finance build up precautionary savings using
Internet WMP and withdraw the balances to provide liquidity when facing negative shocks. For comparison, we examine whether this
risk-smoothing effect through precautionary savings can also be found in traditional financial tools under the development of digital
finance. The results using a dummy indicating whether households hold bank deposit balances as dependent variable are shown in
column 4 Table 9. The coefficient estimate on interaction term, logDFΔlog Y, ~ is insignificant, showing that the liquidity and saving
effect of digital finance are mainly generated not by the traditional bank saving but by the online WMPs provided by the big techs.
Overall, the above analyses provide evidence that the development of digital finance promotes risk sharing through transferred
income from parents, friends and relatives, and also it helps household to build up precautionary savings through Internet investment
and wealth management products, which provides liquidity and thus helps to smooth consumption risks when facing negative income
shocks.

Table 8
Mechanism 1: Where do the remittances come from?
Whether receiving Remittances Whether receiving remittances from parent, other relatives or friends

(1) (2) (3) (4)

~
Δlog Y 0.172 0.154 0.171 0.152
(0.119) (0.120) (0.120) (0.121)
~
logDF  Δlog Y
0.071***
0.068***
0.071***
0.067***
(0.023) (0.023) (0.023) (0.024)
~
logBC  Δlog Y
0.015*
0.015*
0.014*
0.014*
(0.008) (0.008) (0.008) (0.008)
Household & City level Controls Yes Yes Yes Yes
Controls Interactions Yes Yes Yes Yes
HH FE; Time FE Yes Yes Yes Yes
Rural  Time FE No Yes No Yes
Province  Time FE No Yes No Yes
Observations 24,642 24,642 24,642 24,642
R-squared 0.64 0.64 0.63 0.64

Note: This table reports the results for the first mechanism that whether digital financial inclusion helps to smooth risk through facilitating remittance
transfers. Dependent variable: whether household receives remittances (column 1–2) and whether household receives remittances from non-
government parties including parent, other relatives or friends (column 3–4). Δlog Y ~ denotes the household idiosyncratic per capita income
growth. Controls: household level controls: household demographics, household per capita assets, household head years of schooling, age, gender,
smart phone ownership, the use of financial instruments including bank account, social insurance, and business insurance, and occupation dummies;
city level controls: log of the digital finance index (logDF), log of the ratio of bank credit to GDP (logBC), real GDP growth, industrial structure, per
capita expressway mileage, per capita highway mileage. Control interactions: interactions of controls with Δlog Y. ~ Robust standard errors clustered at
the household level are reported in the reported in the parentheses. ***P < 0.01, **P < 0.05, *P < 0.1.

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Table 9
Mechanism 2: Liquidity and saving effect
Internet WMP Bank Deposit

(1) (2) (3) (4)

~
Δlog Y
0.302***
0.281***
0.281***
0.479***
(0.068) (0.067) (0.067) (0.166)
~
logDF  Δlog Y 0.061*** 0.057*** 0.057***
0.005
(0.013) (0.013) (0.013) (0.023)
~
logBC  Δlog Y
0.008**
0.007*
0.008** 0.004
(0.004) (0.004) (0.004) (0.006)
Household & City level Controls Yes Yes Yes Yes
Controls Interactions Yes Yes Yes Yes
HH FE; Time FE Yes Yes Yes Yes
Rural  Time FE No No Yes Yes
Province  Time FE No Yes Yes Yes
Observations 28,972 28,972 28,972 17,522
R-squared 0.43 0.44 0.44 0.16

Note: This table reports the results for the second mechanism that whether digital financial inclusion helps to generate the liquidity and saving effects.
Dependent variable: whether household has investment in Internet wealth management products (column 1–3) and whether household holds current
deposits (column 4). Δlog Y ~ denotes the household idiosyncratic per capita income growth. Controls: household level controls: household de-
mographics, household per capita assets, household head years of schooling, age, gender, smart phone ownership, the use of financial instruments
including bank account, social insurance, and business insurance, and occupation dummies; city level controls: log of the digital finance index (logDF),
log of the ratio of bank credit to GDP (logBC), real GDP growth, industrial structure, per capita expressway mileage, per capita highway mileage.
~ Robust standard errors clustered at the household level are reported in the reported in the
Control interactions: interactions of controls with Δlog Y.
parentheses. ***P < 0.01, **P < 0.05, *P < 0.1.

6. Conclusion

The leapfrogging of Fintech in China has made it possible that households could better insure themselves against idiosyncratic
income shocks. In this paper, we examine the implications of improved digital financial development for the patterns of risk sharing
among different groups of households using a variety of empirical approaches. The potential for digital technology, especially mobile
payments and transfers, and online investment and wealth management services provided by private Fintech companies, to transform
the lives of household is so far little addressed. We present convincing evidence that the rise of digital finance has had a significant
impact on the ability of households to share risks, and this is not just attributable to improved ability of risk sharing through the
reduction in transaction costs of real time transfer of purchasing power across long distances that digital financial service provides, but
also due to the liquidity and saving effects that digital financial investment products may generate.
Although digital technology makes the online lending based on credit scoring through the big data possible, which could facilitate
self-insurance, we find that two important mechanisms that lie behind the improved risk bearing are the abilities of better risk sharing
and self-insurance. When experiencing negative idiosyncratic income growth, households, especially the poor are more likely to receive
transfer income from parents and from relatives and friends, and/or at the same time, are more likely to use their savings in the online
money fund products to smooth the consumption growth. These results highlight the transaction costs when using informal networks to
smooth risk and the liquidity and saving effects generated from the digital finance to self-insurance.
Such effects are valuable since digital finance could generate welfare gains by reducing the volatility of household consumption
growth and by delinking fluctuations in household specific consumption and income growth. Our empirical results show these effects
are more significant for the household with lower income. Thus, the welfare gains in the long term could be larger if the dynamics of
idiosyncratic income growth are driven by random and temporary negative shocks. As mobile payment and other digital technologies
are adopted by broader businesses and enterprises, the efficiency and productivity gains could be realized.
This paper also points to a large and unfinished research agenda. Besides exploration into the heterogeneous effects of the devel-
opment of digital finance and traditional banking credit market on the sensitivity of idiosyncratic household consumption growth to
income growth, one issue is to better understand the specific effect of household access to digital finance. This requires the household-
level measures of the use of digital finance, which would be possible in the future design of CHFS.
Another important issue is to further distinguish between the extensive margin and intensive margin on transfer and savings. In the
mechanism analyses, we could only identify the extensive margin both on the remittances and the liquidity and saving effect for now.
With the availability of household-level measures of the access to digital finance and data on the quantity of remittances and online
WMPs, one can further identify the intensive margins of shock on the idiosyncratic income growth under a difference in difference
framework.
The third issue is the net welfare implications of digital finance remain unclear. While digital finance has resulted in promoting risk
smoothing by improved risk sharing and self-insurance, it may also impose costs. Without proper protection to financial consumers, the
development of Fintech is inclined to motivate the incentives of several individuals to over-borrow from online platforms. The resulted
over-consumption is often beyond consumers’ affordability, which in turn, increases financial burdens on consumers. This might also
impose pressure on the kinship networks and thus force other members to hide their income or wealth (Baland et al., 2011). New digital

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inequality problem might arise as some do not have access to mobile payment and other digital financial services. It would be interesting
to explore these issues in future works.

Declaration of competing interest

Xun Wang: None. Xue Wang: None.

Appendix A

The Construction of the Dummy of Holding Online Wealth Management Products.

The construction of the dependent variable of column 1–4 in Table 6 is based on the following questions conducted by CHFS: (i)
What kind of payment method does your family use for online sale of agricultural products? (Third-party payment platform) (ii) Which
kind of payment method do you use most frequently for your business? (Alipay or WeChat Pay) (iii) What is the main reason that your
household uses online banking? (Transfer money to Alipay or WeChat-pay account) (iv) What do you usually use mobile banking for?
(Transfer money to Alipay or WeChat-pay account) (v) Do you have any other Internet wealth management products? (Yes, Jing Dong
finance, Baidu finance micro-channels or Shopkeeper wallet, P2P lending, crowdfunding etc.) (vi) What do you usually do with your
mobile phone? (Online shopping, mobile banking service) We fully employ the information to construct a dummy equal to 1 if
households choose the item in the brackets, implying the use of mobile payment in some payment scenarios. In 2014, the CHFS survey
didn't ask information on the use of Internet wealth management directly, however, it is worth noting that China's digital finance
experienced explosive growth after the launch of Yu’E Bao in 2013, an affiliated wealth management product in Alipay. There are 190
million users of Alipay1 in 2014, and among which 185 million users have a Yu’E Bao2 account. Nearly every mobile payment user owns
an Internet wealth management account, so this variable further proxies for the use of Internet wealth management products. In 2017,
we use the same way to construct a proxy variable for the use of Internet wealth management products. The questionnaire asked for
information on the mobile payment usage more directly: (i) What payment tool do you usually use (Mobile payment including AliPay,
WeChat Pay and etc.)? (ii) Do you have any other Internet wealth management products? (Yes, Jing Dong finance, Baidu finance micro-
channels or Shopkeeper wallet, P2P lending, crowdfunding etc.)

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