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The informal economy has traditionally played an important role in most Caribbean economies. Indeed, small family-owned plots supplied most of the domestic demand for agricultural commodities. Most Caribbean economies are now primarily service-oriented, however, the informal sector still plays a major role in most of their economies. There are disadvantages to an over reliance on the informal sector: low tax yields and a focus mainly on the domestic market. This paper argues, nonetheless, that the informal sector is a key mechanism for insulating households from the effects of large negative economic shocks. The study therefore investigates the effects of the size of the informal economy on economic volatility in various Caribbean islands with emphasis on consumption volatility. The results are not meant to argue for policies to support the growth and penetration of the informal sector, but instead policies aimed at supporting entrepreneurship within the region.