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Precautionary Saving and Consumption Smoothing Across Time and Possibilities

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  • Miles Kimball

    (Survery Research Center (SRC))

  • Philippe Weil

Abstract

This Paper examines how aversion to risk and aversion to intertemporal substitution determines the strength of the precautionary saving motive in a two-period model with Kreps-Porteus preferences. For small risks, we derive a measure of the strength of the precautionary saving motive, which generalizes the concept of ‘prudence’ introduced by Kimball (1990b). For large risks, we show that decreasing absolute risk aversion guarantees that the precautionary saving motive is stronger than risk aversion, regardless of the elasticity of intertemporal substitution. Holding risk preferences fixed, the extent to which the precautionary saving motive is stronger than risk aversion increases with the elasticity of intertemporal substitution. We derive sufficient conditions for a change in risk preferences alone to increase the strength of the precautionary saving motive and for the strength of the precautionary saving motive to decline with wealth. Within the class of constant elasticity of intertemporal substitution, constant-relative risk aversion utility functions, these conditions are also necessary.

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Bibliographic Info

Paper provided by Sciences Po in its series Sciences Po publications with number 4005.

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Date of creation: Aug 2003
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Handle: RePEc:spo:wpmain:info:hdl:2441/8704

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Keywords: Consumption; intertemporal substitution; Kreps-Porteus; precautionary; risk aversion; saving; smoothing and uncertainty;

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References

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  1. Caballero, Ricardo J., 1990. "Consumption puzzles and precautionary savings," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(1), pages 113-136, January.
  2. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, Econometric Society, vol. 46(1), pages 185-200, January.
  3. Barsky, Robert B & Mankiw, N Gregory & Zeldes, Stephen P, 1986. "Ricardian Consumers with Keynesian Propensities," American Economic Review, American Economic Association, American Economic Association, vol. 76(4), pages 676-91, September.
  4. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
  5. Skinner, Jonathan, 1988. "Risky income, life cycle consumption, and precautionary savings," Journal of Monetary Economics, Elsevier, Elsevier, vol. 22(2), pages 237-255, September.
  6. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, Econometric Society, vol. 57(4), pages 937-69, July.
  7. Pratt, John W, 1988. " Aversion to One Risk in the Presence of Others," Journal of Risk and Uncertainty, Springer, Springer, vol. 1(4), pages 395-413, December.
  8. Stephen Zeldes, . "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 20-86, Wharton School Rodney L. White Center for Financial Research.
  9. Barsky, Robert B, 1989. "Why Don't the Prices of Stocks and Bonds Move Together?," American Economic Review, American Economic Association, American Economic Association, vol. 79(5), pages 1132-45, December.
  10. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, Econometric Society, vol. 58(1), pages 53-73, January.
  11. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, Elsevier, vol. 5(3), pages 308-335, December.
  12. Farmer, Roger E A, 1990. "Rince Preferences," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 43-60, February.
  13. Miles S. Kimball & N. Gregory Mankiw, 1988. "Precautionary Saving and the Timing of Taxes," NBER Working Papers 2680, National Bureau of Economic Research, Inc.
  14. Miles S. Kimball, 1990. "Precautionary Saving and the Marginal Propensity to Consume," NBER Working Papers 3403, National Bureau of Economic Research, Inc.
  15. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
  16. Barsky, Robert B, et al, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(2), pages 537-79, May.
  17. Lars Hansen & Thomas Sargent & Thomas Tallarini, . "Robust Permanent Income and Pricing," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-51, Carnegie Mellon University, Tepper School of Business.
  18. Selden, Larry, 1978. "A New Representation of Preferences over "Certain A Uncertain" Consumption Pairs: The "Ordinal Certainty Equivalent" Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 46(5), pages 1045-60, September.
  19. Kihlstrom, Richard E & Romer, David & Williams, Steve, 1981. "Risk Aversion with Random Initial Wealth," Econometrica, Econometric Society, Econometric Society, vol. 49(4), pages 911-20, June.
  20. repec:fth:harver:1421 is not listed on IDEAS
  21. Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
  22. Weil, Philippe, 1993. "Precautionary Savings and the Permanent Income Hypothesis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 60(2), pages 367-83, April.
  23. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 29-42, February.
  24. van der Ploeg, Frederick, 1993. "A Closed-Form Solution for a Model of Precautionary Saving," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 60(2), pages 385-95, April.
  25. Robert B. Barsky & Miles S. Kimball & F. Thomas Juster & Matthew D. Shapiro, 1995. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Survey," NBER Working Papers 5213, National Bureau of Economic Research, Inc.
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