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Non-expected Utility, Saving, and Portfolios

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Author Info
Michael Haliassos (The University of Cyprus)
Christis Hassapis (The University of Cyprus)

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Abstract

Existing findings suggest that standard, frictionless, expected-utility models have difficulty accounting for average and for median holdings of wealth and of risky assets, partly as a result of the largely unexplained limited proportion of stockholders among households. We analyze life-cycle wealth accumulation and portfolio choice under career uncertainty and quantifiable departures from expected utility maximization. Our specification nests expected utility and three types of non-expected utility: (i) Kreps-Porteus preferences that disentangle risk aversion from elasticity of substitution, (ii) Yaari's Dual Theory of Choice, and (iii) Quiggin's Rank-dependent Utility. Specifications (ii) and (iii) exhibit "first-order" risk aversion and kinked indifference curves. Solution of such models under multiple sources of risk presents conceptual and computational difficulties. We introduce a notion of equilibrium and a computational algorithm appropriate for such setups. Computed wealth and stockholding, based on calibrated income processes for three education categories, are compared to the 1992 Survey of Consumer Finances. Rank-dependent utility enhances the importance of precautionary effects. Contrary to priors in the literature, solutions are not typically at kinks; neither kinks nor actual solutions involve zero stockholding when income risk is recognized; and yet predictions about average wealth and risky assets tend to improve for all education categories. Mere disentangling of risk aversion from elasticity has small effects, while dual theory predictions are farther from the data and the signs of precautionary effects are reversed.

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Paper provided by EconWPA in its series Macroeconomics with number 9709003.

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Date of creation: 30 Sep 1997
Date of revision: 11 Apr 1998
Handle: RePEc:wpa:wuwpma:9709003

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Related research
Keywords: precautionary motives; non-expected utility; first-order risk aversion; portfolio choice; saving;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

References listed on IDEAS
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  1. Haliassos, Michael, 1994. "On Perfect Foresight Models of a Stochastic World," Economic Journal, Royal Economic Society, vol. 104(424), pages 477-91, May. [Downloadable!] (restricted)
  2. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June. [Downloadable!] (restricted)
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  3. Orazio P. Attanasio & James Banks & Sarah Tanner, 2002. "Asset Holding and Consumption Volatility," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 771-792, August. [Downloadable!] (restricted)
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  4. Poterba, J.M. & Samwick, A.A., 1996. "Stock Ownership Patterns, Stock Market Fluctuations, and Consumption," Working papers 96-2, Massachusetts Institute of Technology (MIT), Department of Economics.
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  5. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February. [Downloadable!] (restricted)
  6. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1994. "Income Risk, Borrowing Constraints and Portfolio Choice," CEPR Discussion Papers 888, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Blackwell Publishing, vol. 37(3), pages 353-60, July. [Downloadable!] (restricted)
  8. N. Gregory Mankiw & Stephen P. Zeldes, 1991. "The Consumption of Stockholders and Non-Stockholders," NBER Working Papers 3402, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Zeldes, Stephen P, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 275-98, May. [Downloadable!] (restricted)
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  10. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May. [Downloadable!] (restricted)
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  11. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(1992-2), pages 61-156. [Downloadable!]
  12. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  13. George M. Constantinides & John B. Donaldson & Rajnish Mehra, 2002. "Junior Can'T Borrow: A New Perspective On The Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 269-296, February. [Downloadable!] (restricted)
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  14. R. Glenn Hubbard & Jonathan Skinner & Stephen P. Zeldes, 1994. "The Importance of Precautionary Motives in Explaining Individual and Aggregate Saving," NBER Working Papers 4516, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December. [Downloadable!] (restricted)
  16. Michael Haliassos & Christis Hassapis, 1998. "Borrowing Constraints, Portfolio Choice, and Precautionary Motives: Theoretical Predictions and Empirical Complications," CSEF Working Papers 11, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
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  17. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January. [Downloadable!] (restricted)
  18. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January. [Downloadable!] (restricted)
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  19. Segal, Uzi & Spivak, Avia, 1990. "First order versus second order risk aversion," Journal of Economic Theory, Elsevier, vol. 51(1), pages 111-125, June. [Downloadable!] (restricted)
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  20. Mervyn A. King & Jonathan I. Leape, 1984. "Wealth and Portfolio Composition: Theory and Evidence," NBER Working Papers 1468, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  21. Haliassos, Michael & Bertaut, Carol C, 1995. "Why Do So Few Hold Stocks?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1110-29, September. [Downloadable!] (restricted)
  22. Kydland, Finn E & Prescott, Edward C, 1996. "The Computational Experiment: An Econometric Tool," Journal of Economic Perspectives, American Economic Association, vol. 10(1), pages 69-85, Winter. [Downloadable!] (restricted)
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  23. Bertaut, Carol C. & Haliassos, Michael, 1997. "Precautionary portfolio behavior from a life-cycle perspective," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1511-1542, June. [Downloadable!] (restricted)
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  24. Attanasio, Orazio P & Weber, Guglielmo, 1989. "Intertemporal Substitution, Risk Aversion and the Euler Equation for Consumption," Economic Journal, Royal Economic Society, vol. 99(395), pages 59-73, Supplemen. [Downloadable!] (restricted)
  25. Epstein, Larry G. & Zin, Stanley E., 1990. "'First-order' risk aversion and the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 26(3), pages 387-407, December. [Downloadable!] (restricted)
  26. Fernando Restoy & Philippe Weil, 1998. "Approximate Equilibrium Asset Prices," NBER Working Papers 6611, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Panos Hatzipanayotou & Sajal Lahiri & Michael S. Michael, 2002. "Reforms of Environmental Policies in the Presence of Cross-border Pollution and two Stage Clean Up," University of Cyprus Working Papers in Economics 0203, University of Cyprus Department of Economics. [Downloadable!]
    Other versions:
  2. Li, Youwei & Donkers, Bas & Melenberg, Bertrand, 2006. "The non- and semiparametric analysis of MS models : some applications," Discussion Paper 95, Tilburg University, Center for Economic Research. [Downloadable!]
  3. Nicholas Barberis & Ming Huang, 2006. "The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle," NBER Working Papers 12378, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Panos Pashardes & Soteroula Hajispyrou, 2002. "Consumer Demand and Welfare under Increasing Block Pricing," University of Cyprus Working Papers in Economics 0207, University of Cyprus Department of Economics. [Downloadable!]
  5. Michael Haliassos & Christis Hassapis, 1998. "Borrowing Constraints, Portfolio Choice, and Precautionary Motives: Theoretical Predictions and Empirical Complications," CSEF Working Papers 11, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
    Other versions:
  6. Michael Haliassos, 2002. "Stockholding: Recent Lessons from Theory and Computations," University of Cyprus Working Papers in Economics 0206, University of Cyprus Department of Economics. [Downloadable!]
  7. Haliassos, Michalis & Michaelides, Alexander, 2001. "Portfolio Choice and Liquidity Constraints," CEPR Discussion Papers 2822, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  8. M. Fatih Guvenen, 2002. "Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution: A Macroeconomic Perspective," RCER Working Papers 491, University of Rochester - Center for Economic Research (RCER), revised Mar 2003. [Downloadable!]
    Other versions:
  9. Michael Haliassos & Christis Hassapis, 1998. "Borrowing Constraints, Portfolio Choice, and Precautionary," Macroeconomics 9809008, EconWPA. [Downloadable!]
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