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The Effect of Parameter Uncertainty on Consumption, Wealth, and Welfare

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  • Michael Sampson

    (Professor Emeritus, Department of Economics Concordia University, Canada)

Abstract

This paper looks at precautionary saving when income follows a random walk where the trend parameter μ is unknown. Agents use Bayesian econometrics to determine their beliefs about μ. Parameter uncertainty about μ is shown to dominate all other sources of uncertainty that agents face. We derive a closed-form solution to the model and show that this parameter uncertainty has a big impact on consumption, precautionary savings, and welfare. The effect of this parameter uncertainty on wealth is shown to be permanent.

Suggested Citation

  • Michael Sampson, 2022. "The Effect of Parameter Uncertainty on Consumption, Wealth, and Welfare," Annals of Economics and Finance, Society for AEF, vol. 23(1), pages 1-10, May.
    • Handle: RePEc:cuf:journl:y:2022:v:23:i:1:sampson
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    References listed on IDEAS

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    1. Caballero, Ricardo J, 1991. "Earnings Uncertainty and Aggregate Wealth Accumulation," American Economic Review, American Economic Association, vol. 81(4), pages 859-871, September.
    2. Sampson, Michael, 1991. "The Effect of Parameter Uncertainty on Forecast Variances and Confidence Intervals for Unit Root and Trend Stationary Time-Series Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(1), pages 67-76, Jan.-Marc.
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    Cited by:

    1. Michael Sampson, 2023. "Learning About New Eras," Annals of Economics and Finance, Society for AEF, vol. 24(1), pages 1-12, May.

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    More about this item

    Keywords

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    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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