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Consumption Commitments and Preferences for Risk

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  • Larry Samuelson
  • Andrew Postlewaite

Abstract

We examine an economy in which the cost of consuming some goods can be reduced by making commitments to consumption levels that do not vary across states. For example, moral hazard and matching considerations may make it cheaper to produce housing services via owner-occupied than rented housing, but the transactions costs associated with the former may compel consumers to adopt a realtively inflexible housing consumptin plan. We show that consumption commitments can cause risk-neutral consumers to care a great deal about risk, creating an incentive to insure risks and to bunch uninsured risks together. As a result, workers may preger to avoid wage risk while bearing an unemployment risk that is concentrated in as few states as possible. The interaction between consumptin and labor markets may give rise to multiple equilibria. The basic predictions of the model are compared with corresponding moments of US data on layoff risk and housing consumption.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 162.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:162

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Keywords: risk aversion; consumption commitments; wage contracts;

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References

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  1. Akerlof, George A & Miyazaki, Hajime, 1980. "The Implicit Contract Theory of Unemployment Meets the Wage Bill Argument," Review of Economic Studies, Wiley Blackwell, vol. 47(2), pages 321-38, January.
  2. Lucas, Robert E, Jr & Rapping, Leonard A, 1969. "Real Wages, Employment, and Inflation," Journal of Political Economy, University of Chicago Press, vol. 77(5), pages 721-54, Sept./Oct.
  3. Ellingsen, T. & Holden, S., 1995. "Sticky Consumption and Rigid Wages," Memorandum 21/1995, Oslo University, Department of Economics.
  4. Adam Szeidl & Raj Chetty, 2004. "Consumption Commitments and Asset Prices," 2004 Meeting Papers 354, Society for Economic Dynamics.
  5. Kihlstrom, Richard E & Mirman, Leonard J, 1981. "Constant, Increasing and Decreasing Risk Aversion with Many Commodities," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 271-80, April.
  6. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  7. Baily, Martin Neil, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 37-50, January.
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Cited by:
  1. Holden, Steinar & Wulfsberg, Fredrik, 2007. "Are real wages rigid downwards?," Memorandum 07/2007, Oslo University, Department of Economics.
  2. Stephen H. Shore & Todd Sinai, 2010. "Commitment, Risk, and Consumption: Do Birds of a Feather Have Bigger Nests?," The Review of Economics and Statistics, MIT Press, vol. 92(2), pages 408-424, May.
  3. Steinar Holden & Fredrik Wulfsberg, 2007. "How strong is the case for downward real wage rigidity?," Working Papers 07-6, Federal Reserve Bank of Boston.
  4. Raj Chetty & Adam Szeidl, 2006. "Consumption Commitments and Risk Preferences," NBER Working Papers 12467, National Bureau of Economic Research, Inc.
  5. Drew Fudenberg & David K Levine, 2009. "Risk, Delay, and Convex Self-Control Costs," Levine's Working Paper Archive 843644000000000332, David K. Levine.
  6. Adam Szeidl & Raj Chetty, 2005. "Consumption Commitments: Neoclassical Foundations for Habit Formation," 2005 Meeting Papers 122, Society for Economic Dynamics.
  7. Holden, Steinar & Wulfsberg, Fredrik, 2009. "How strong is the macroeconomic case for downward real wage rigidity?," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 605-615, May.

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