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The volatility trap: Precautionary saving, investment, and aggregate risk

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  • Reda Cherif
  • Fuad Hasanov

Abstract

We study the effects of permanent and temporary income shocks on precautionary saving and investment in a “store†or†sow†model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment or a “volatility trap,†namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump†shaped function of the volatility of permanent shocks, as predicted by the model.

Suggested Citation

  • Reda Cherif & Fuad Hasanov, 2018. "The volatility trap: Precautionary saving, investment, and aggregate risk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 23(2), pages 174-185, April.
    • Handle: RePEc:wly:ijfiec:v:23:y:2018:i:2:p:174-185
    DOI: 10.1002/ijfe.1610
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    Cited by:

    1. Muhammad Ayaz Khan & Muhammad Shafiq & Shrafat Ali Sair & Aamir Sohail & Muhammad Hasnain Ali, 2025. "Sustainability in Retail Investment Behaviors: A Post-COVID-19 Exploration in Emerging Economy—The Mediating Role of Financial Literacy," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 16(1), pages 3462-3480, March.
    2. Cherif, Reda & Hasanov, Fuad, 2013. "Oil Exporters’ Dilemma: How Much to Save and How Much to Invest," World Development, Elsevier, vol. 52(C), pages 120-131.
    3. Bin Grace Li & Pranav Gupta & Jiangyan Yu, 2017. "From natural resource boom to sustainable economic growth: Lessons from Mongolia," International Economics, CEPII research center, issue 151, pages 7-25.
    4. Mohey-ud-din, Ghulam & Siddiqi, Muhammad Wasif, 2013. "GDP Fluctuations and Private Investment: A Macro Panel Analysis of Selected South Asian Countries," MPRA Paper 60231, University Library of Munich, Germany, revised 15 Jun 2014.
    5. Araujo, Juliana D. & Li, Bin Grace & Poplawski-Ribeiro, Marcos & Zanna, Luis-Felipe, 2016. "Current account norms in natural resource rich and capital scarce economies," Journal of Development Economics, Elsevier, vol. 120(C), pages 144-156.
    6. Karim Barhoumi & Reda Cherif & Mr. Nooman Rebei, 2016. "Stochastic Trends, Debt Sustainability and Fiscal Policy," IMF Working Papers 2016/059, International Monetary Fund.
    7. Barhoumi, Karim & Cherif, Reda & Rebei, Nooman, 2018. "Stochastic trends and fiscal policy," Economic Modelling, Elsevier, vol. 75(C), pages 256-267.
    8. Lukáš Kučera & Karel Brůna, 2014. "Dynamika změny stavu zásob a její synchronizace s cyklem úspor a importu v české republice v letech 1999-2012 [A Dynamics of Inventories and Its Synchronization with a Cycle of Savings and Import i," Politická ekonomie, Prague University of Economics and Business, vol. 2014(5), pages 605-629.

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