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Precautionary Saving: An Explanation for Excess Sensitivity of Consumption

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  • Normandin, Michel

Abstract

The permanent income hypothesis under certainty equivalence yields a martingale consumption process. Empirically, this hypothesis is rejected because consumption is excessively sensitive to anticipated income. One approach to account for excess sensitivity is to relax certainty equivalence by using utility functions that induce precautionary saving. This article analyzes a hyperbolic absolute risk-aversion utility function. Empirically, some reasonable parameterizations of this specification allow one to match the excess sensitivity associated with the data. Also, these parameterizations permit one to account for the excess smoothness problem. However, excess sensitivity and excess smoothness do not reflect the same phenomenon.

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Bibliographic Info

Article provided by American Statistical Association in its journal Journal of Business and Economic Statistics.

Volume (Year): 12 (1994)
Issue (Month): 2 (April)
Pages: 205-19

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Handle: RePEc:bes:jnlbes:v:12:y:1994:i:2:p:205-19

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Cited by:
  1. Christopher D. Carroll & Karen E. Dynan & Spencer D. Krane, 2003. "Unemployment Risk and Precautionary Wealth: Evidence from Households' Balance Sheets," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 586-604, August.
  2. Sule Alan, 2004. "Precautionary Wealth and Portfolio Allocation: Evidence from Canadian Microdata," Social and Economic Dimensions of an Aging Population Research Papers 117, McMaster University.
  3. Normandin, Michel, 1993. "Épargne de précaution et revenu de travail incertain : un survol de la littérature," L'Actualité Economique, Société Canadienne de Science Economique, vol. 69(4), pages 347-364, décembre.
  4. Lage, Maureen J., 1997. "The permanent income hypothesis under permanent-transitory confusion," Journal of Economics and Business, Elsevier, vol. 49(1), pages 77-90, February.
  5. Arjen H. Siegmann, 2001. "Optimal Saving Rules for Loss-Averse Agents under Uncertainty," Tinbergen Institute Discussion Papers 01-079/4, Tinbergen Institute.
  6. Marc-Andre Letendre & Gregor Smith, 2000. "Precautionary saving and portfolio allocation: DP by GMM," Working Papers 1247, Queen's University, Department of Economics.

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