Risk Aversion, Intertemporal Substitution And Consumption: The Cara-Lq Problem
AbstractThis paper employs the recursive utility approach, based on quadratic felicity functions and constant absolute risk aversion, to distinguish between risk aversion and intertemporal substitution. Stochastic dynamic programming yields closed-loop linear decision rules for the CARA-LQ problem. Certainty equivalence no longer holds, but instead the decision maker plays a min-max strategy against nature. When applied to a life cycle consumption problem, one finds a rationale for precautionary saving and a larger sensitivity of changes in consumption to income innovations. It is also shown that consumers with Ricardian rationality can display a Keynesian propensity to consume out of a current tax cut.
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Bibliographic InfoPaper provided by Tilburg - Center for Economic Research in its series Papers with number 8953.
Length: 21 pages
Date of creation: 1989
Date of revision:
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risk aversion ; linear models ; consumption ; savings;
Other versions of this item:
- van der Ploeg, Frederick, 1990. "Risk Aversion, Intertemporal Substitution and Consumption: the CARA-LQ Problem," CEPR Discussion Papers 359, C.E.P.R. Discussion Papers.
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- Mark Huggett, 2004.
"Precautionary Wealth Accumulation,"
Review of Economic Studies,
Wiley Blackwell, vol. 71, pages 769-781, 07.
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