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A Closed-form Solution for a Model of Precautionary Saving

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  • Frederick van der Ploeg

Abstract

This paper analyses life-cycle consumption plans and distinguishes between temporal risk aversion and intertemporal substitution. The results assume that felicity functions are quadratic and that income follows a linear model with normally distributed errors. Stochastic dynamic programming then yields closed-loop linear decision rules. Certainty equivalence no longer holds, but instead households play a min-max strategy against nature. One finds a rationale for precautionary saving and a larger sensitivity of changes in consumption to income innovations.

Suggested Citation

  • Frederick van der Ploeg, 1993. "A Closed-form Solution for a Model of Precautionary Saving," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(2), pages 385-395.
    • Handle: RePEc:oup:restud:v:60:y:1993:i:2:p:385-395.
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    File URL: http://hdl.handle.net/10.2307/2298063
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