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The Joint Consumption/Asset Demand Decision: A Case Study in Robust Estimation

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  • Marjorie A. Flavin
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    Abstract

    The paper uses a previously unexploited data set -- the Michigan Survey of Consumer Finances -- to ask whether the finding that consumption tracks current income more closely than is consistent with the permanent income hypothesis can be attributed solely or partially to borrowing constraints. Using household data on income and asset stocks, the paper studies the saving side of the consumption/saving decision, and thus provides inferences on a comprehensive concept of consumption. To limit the influence of outliers, the paper uses a robust instrumental variables estimator, and argues that achieving robustness with respect to leverage points is actually simpler, both conceptually and computationally, in an instrumental variables context than in the OLS context. The results indicate that households do use asset stocks to smooth their consumption, although this smoothing is far from complete. However, there is no evidence that the excess sensitivity of consumption to current income is caused by borrowing constraints. Compared to the conventional results, the robust instrumental variables estimates are more stable across different subsamples, more consistent with the theoretical specification of the model, and indicate that some of the most striking findings in the conventional results were attributable to a single, highly unusual observation.

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    File URL: http://www.nber.org/papers/w3802.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3802.

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    Date of creation: Aug 1991
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    Handle: RePEc:nbr:nberwo:3802

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    Cited by:
    1. Chah, Eun Young & Ramey, Valerie A & Starr, Ross M, 1995. "Liquidity Constraints and Intertemporal Consumer Optimization: Theory and Evidence from Durable Goods," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(1), pages 272-87, February.
    2. Nicholas S. Souleles, 2001. "Consumer Sentiment: Its Rationality and Usefulness in Forecasting Expenditure - Evidence from the Michigan Micro Data," NBER Working Papers 8410, National Bureau of Economic Research, Inc.
    3. John A. James & Michael G. Palumbo & Mark Thomas, 2007. "Consumption smoothing among working-class American families before social insurance," Oxford Economic Papers, Oxford University Press, vol. 59(4), pages 606-640, October.
    4. Giamboni, Luigi & Millemaci, Emanuele & Waldmann, Robert, 2007. "Evaluating how predictable errors in expected income affect consumption," MPRA Paper 12939, University Library of Munich, Germany.
    5. Limosani, Michele & Millemaci, Emanuele, 2011. "Evidence on excess sensitivity of consumption to predictable income growth," Research in Economics, Elsevier, Elsevier, vol. 65(2), pages 71-77, June.
    6. Paul Frijters & John P. Haisken-DeNew & Michael Shields, 2003. "How Well Do Individuals Predict Their Future Life Satisfaction? Rationality and Learning Following a Nationwide Exogenous Shock," CEPR Discussion Papers, Centre for Economic Policy Research, Research School of Economics, Australian National University 468, Centre for Economic Policy Research, Research School of Economics, Australian National University.

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