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Precautionary Saving: An Explanation for Excess Smoothness of Consumption

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Abstract

The permanent income hypothesis under certainty equivalence implies that optimal consumption is more volatile than labour income, when labour income is positively autocorrelated in first differences. Empirically, certainty equivalence is rejected because observed consumption is excessively smooth. One approach to account for excess smoothness is to relax certainty equivalence by using utility functions which induce precautionary saving. This paper analyzes a hyperbolic absolute risk aversion utility function. Some reasonable parametrizations of this specification imply that consumption is smoother than labour income and that the relative smoothness matches the data. L'hypothèse de revenu permanent en équivalence certaine implique que la consommation optimale est plus variable que le revenu de travail lorsque ce dernier est positivement autocorrélé en première différence. Empiriquement, l'équivalence certaine est rejetée parce que la consommation observée est excessivement lisse. Une stratégie visant à expliquer le lissage excessif consiste à relâcher la propriété d'équivalence certaine afin de considérer l'épargne de précaution. Ce papier analyse l'épargne de précaution découlant d'une fonction d'utilité dont l'aversion absolue au risque est hyperbolique. Certaines spécifications raisonnables de cette fonction impliquent que la consommation est plus lisse que le revenu de travail et que le lissage relatif réplique celui observé.

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Bibliographic Info

Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 4.

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Length: 32 pages
Date of creation: Oct 1992
Date of revision:
Handle: RePEc:cre:crefwp:4

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Keywords: precautionary savings; excess smoothness; numerical solutions; exact inference;

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Cited by:
  1. 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.

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