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Precautionary Savings in a Small Open Economy Revisited

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  • Agustin Roitman
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    Abstract

    A common assumption in standard economic models is that agents are risk-averse and prudent, and it is often argued that prudence is necessary to generate precautionary savings. This paper shows that prudence is not necessary to generate precautionary savings in small open economy models with more than two periods. A new class of preferences, which enables the isolation of the effect of risk aversion on precautionary savings, is introduced. The effects of changes in risk aversion, interest rates, and persistence and volatility of shocks on average asset holdings are qualitatively identical to the ones observed for standard constant-elasticity-of-substitution preferences. These results show that the almost universal assertion in the literature - that only prudent consumers can generate positive levels of precautionary savings - is simply incorrect.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/253.

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    Length: 23
    Date of creation: 01 Nov 2011
    Date of revision:
    Handle: RePEc:imf:imfwpa:11/253

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    Related research

    Keywords: Borrowing; Forecasting models; Interest rates; risk aversion; capital markets; international capital markets; world capital markets;

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    References

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    1. Mark Huggett, 2004. "Precautionary Wealth Accumulation," Review of Economic Studies, Oxford University Press, vol. 71(3), pages 769-781.
    2. Marco E. Terrones & Enrique G. Mendoza & Ceyhun Bora Durdu, 2008. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism," 2008 Meeting Papers 56, Society for Economic Dynamics.
    3. Huggett, Mark & Ospina, Sandra, 2001. "Aggregate precautionary savings: when is the third derivative irrelevant?," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 373-396, October.
    4. Martin Browning & Annamaria Lusardi, 1996. "Household Saving: Micro Theories and Micro Facts," Discussion Papers 96-01, University of Copenhagen. Department of Economics.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Precaution versus prudence
      by Economic Logician in Economic Logic on 2011-12-27 15:27:00

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    1. Economic Logic blog

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