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Changes in Risk and the Demand for Saving

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  • Louis Eeckhoudt
  • Harris Schlesinger

Abstract

How does risk affect saving? Empirical work typically examines the effects of detectible differences in risk within the data. How these differences affect saving in theoretical models depends on the metric one uses for risk. For labor-income risk, second-degree increases in risk require prudence to induce increased saving demand. However, prudence is not necessary for first-degree risk increases and not sufficient for higher-degree risk increases. For increases in interest rate risk, a precautionary effect and a substitution effect need to be compared. This paper provides necessary and sufficient conditions on preferences for an Nth-degree change in risk to increase saving.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2008/wp-cesifo-2008-09/cesifo1_wp2388.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2388.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2388

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Keywords: precautionary saving; prudence; stochastic dominance; temperance;

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References

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  1. Jonathan A. Parker & Bruce Preston, 2004. "Precautionary Saving and Consumption Fluctuations," Working Papers 140, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
  2. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 37(3), pages 353-60, July.
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  5. Lajeri-Chaherli, Fatma, 2004. "Proper prudence, standard prudence and precautionary vulnerability," Economics Letters, Elsevier, Elsevier, vol. 82(1), pages 29-34, January.
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  7. Kabir K. Dutta & David F. Babbel, 2005. "Extracting Probabilistic Information from the Prices of Interest Rate Options: Tests of Distributional Assumptions," The Journal of Business, University of Chicago Press, vol. 78(3), pages 841-870, May.
  8. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, Elsevier, vol. 47(3), pages 545-579, June.
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  11. EECKHOUDT, Louis & SCHLESINGER, Harris, . "Putting risk in its proper place," CORE Discussion Papers RP -1871, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  16. Huggett, Mark & Ospina, Sandra, 2001. "Aggregate precautionary savings: when is the third derivative irrelevant?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(2), pages 373-396, October.
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