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The Volatility Trap

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Author Info

  • Reda Cherif
  • Fuad Hasanov

Abstract

We study the effects of permanent and temporary income shocks on precautionary saving and investment in a "store-or-sow" model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment, or a "volatility trap." Namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump-shaped function of the volatility of permanent shocks, as predicted by the model.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 12/134.

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Length: 21
Date of creation: 01 May 2012
Date of revision:
Handle: RePEc:imf:imfwpa:12/134

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Related research

Keywords: Economic growth; Economic models; External shocks; Savings; investment rate; standard deviation; nonlinear relationship; correlation; statistics; descriptive statistics; liquidity constraints; standard deviations; equation; nonlinearity; private investment; domestic saving; risky investment; random walk; probability; calibration; gross fixed capital formation; domestic investment; scatter plot; investment risk; investment behavior; investment growth; curve relationship; logarithm; statistically significant effect; commodity prices; expected returns; optimization; functional form; samples; fixed capital; survey; surveys;

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References

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  1. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary demand for foreign assets in sudden stop economies: an assessment of the new mercantilism," International Finance Discussion Papers 911, Board of Governors of the Federal Reserve System (U.S.).
  2. Aghion, Philippe & Bacchetta, Philippe & Ranciere, Romain & Rogoff, Kenneth S., 2009. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," Scholarly Articles 12490419, Harvard University Department of Economics.
  3. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
  4. Francois Gourio, 2009. "Disaster risk and business cycles," 2009 Meeting Papers 1176, Society for Economic Dynamics.
  5. Borensztein, Eduardo & Jeanne, Olivier & Sandri, Damiano, 2009. "Macro-Hedging for Commodity Exporters," CEPR Discussion Papers 7513, C.E.P.R. Discussion Papers.
  6. Park, Donghyun & Shin, Kwanho, 2009. "Saving, Investment, and Current Account Surplus in Developing Asia," ADB Economics Working Paper Series 158, Asian Development Bank.
  7. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  8. Reda Cherif & Fuad Hasanov, 2012. "Oil Exporters' Dilemma," IMF Working Papers 12/4, International Monetary Fund.
  9. Luca Antonio Ricci & Marcos Chamon & Yuanyan Sophia Zhang, 2011. "Country Insurance Using Financial Instruments," IMF Working Papers 11/169, International Monetary Fund.
  10. Douglas Dacy & Fuad Hasanov, 2011. "A Finance Approach To Estimating Consumption Parameters," Economic Inquiry, Western Economic Association International, vol. 49(1), pages 122-154, 01.
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Cited by:
  1. Juliana Dutra Araujo & Grace Bin Li & Marcos Poplawski-Ribeiro & Luis-Felipe Zanna, 2013. "Current Account Norms in Natural Resource Rich and Capital Scarce Economies," IMF Working Papers 13/80, International Monetary Fund.

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