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Precautionary Saving: An Explanation for Excess Sensitivity of Consumption

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.

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Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 3.

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Length: 42 pages
Date of creation: Oct 1992
Publication status: Published, Journal of Business and Economic Statistics, April 1994
Handle: RePEc:cre:crefwp:3
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