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Precautionary Saving: An Explanation for Excess Sensitivity of Consumption

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Abstract

The permanent income hypothesis under certainty equivalence yields a martingale consumption process. Empirically, this hypothesis is rejected because consumption is excessively sensitive to anticipated income. One approach to account for excess sensitivity is to relax certainty equivalence by using utility functions which induce precautionary saving. This paper analyzes a hyperbolic absolute risk avesion utility function. Empirically, some reasonable parametrizations of this specification allow one to match the excess sensitivity associated with the data. Also, these parametrizations permit one to account for the excess smoothness problem. However, it is shown that excess sensitivity and excess smoothness do not reflect the same phenomenon. L'hypothèse de revenu permanent en équivalence certaine implique que la consommation est une martingale. Empiriquement, cette hypothèse est rejetée parce que la consommation est excessivement sensible au revenu anticipé. Une stratégie visant à expliquer la sensibilité excessive consiste à relâcher la propriété d'équivalence certaine afin de considérer l'épargne de précaution. Ce papier analyse l'épargne de précaution découlant d'une fonction d'utilité dont l'aversion absolue au risque est hyperbolique. Empiriquement, certaines spécifications de cette fonction permettent de répliquer la sensibilité excessive observée. Aussi, ces spécifications expliquent le lissage excessif. Toutefois, la sensibilité excessive et le lissage excessif ne reflètent pas le même phénomène.

Suggested Citation

  • Michel Normandin, 1992. "Precautionary Saving: An Explanation for Excess Sensitivity of Consumption," Cahiers de recherche CREFE / CREFE Working Papers 3, CREFE, Université du Québec à Montréal.
    • Handle: RePEc:cre:crefwp:3
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    Cited by:

    1. Normandin, Michel, 1993. "Épargne de précaution et revenu de travail incertain : un survol de la littérature," L'Actualité Economique, Société Canadienne de Science Economique, vol. 69(4), pages 347-364, décembre.
    2. Christopher D. Carroll & Karen E. Dynan & Spencer D. Krane, 2003. "Unemployment Risk and Precautionary Wealth: Evidence from Households' Balance Sheets," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 586-604, August.
    3. Lage, Maureen J., 1997. "The permanent income hypothesis under permanent-transitory confusion," Journal of Economics and Business, Elsevier, vol. 49(1), pages 77-90, February.
    4. Siegmann, Arjen, 2002. "Optimal saving rules for loss-averse agents under uncertainty," Economics Letters, Elsevier, vol. 77(1), pages 27-34, September.
    5. Letendre, Marc-Andre & Smith, Gregor W., 2001. "Precautionary saving and portfolio allocation: DP by GMM," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 197-215, August.
    6. James C. Morley, 2007. "The Slow Adjustment of Aggregate Consumption to Permanent Income," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2‐3), pages 615-638, March.
    7. Sule Alan, 2004. "Precautionary Wealth and Portfolio Allocation: Evidence from Canadian Microdata," Social and Economic Dimensions of an Aging Population Research Papers 117, McMaster University.

    More about this item

    Keywords

    martingale hypothesis; excess sensitivity; precautionary savings; exact tests.;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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