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Precautionary Savings in a Small Open Economy Revisited

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  • Agustin Roitman

Abstract

A common assumption in standard economic models is that agents are risk-averse and prudent, and it is often argued that prudence is necessary to generate precautionary savings. This paper shows that prudence is not necessary to generate precautionary savings in small open economy models with more than two periods. A new class of preferences, which enables the isolation of the effect of risk aversion on precautionary savings, is introduced. The effects of changes in risk aversion, interest rates, and persistence and volatility of shocks on average asset holdings are qualitatively identical to the ones observed for standard constant-elasticity-of-substitution preferences. These results show that the almost universal assertion in the literature - that only prudent consumers can generate positive levels of precautionary savings - is simply incorrect.

Suggested Citation

  • Agustin Roitman, 2011. "Precautionary Savings in a Small Open Economy Revisited," IMF Working Papers 11/253, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:11/253
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    References listed on IDEAS

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    1. Martin Browning & Annamaria Lusardi, 1996. "Household Saving: Micro Theories and Micro Facts," Journal of Economic Literature, American Economic Association, vol. 34(4), pages 1797-1855, December.
    2. Durdu, Ceyhun Bora & Mendoza, Enrique G. & Terrones, Marco E., 2009. "Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism," Journal of Development Economics, Elsevier, vol. 89(2), pages 194-209, July.
    3. Hayne E. Leland, 1968. "Saving and Uncertainty: The Precautionary Demand for Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 82(3), pages 465-473.
    4. Huggett, Mark & Ospina, Sandra, 2001. "Aggregate precautionary savings: when is the third derivative irrelevant?," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 373-396, October.
    5. Mark Huggett, 2004. "Precautionary Wealth Accumulation," Review of Economic Studies, Oxford University Press, vol. 71(3), pages 769-781.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Precaution versus prudence
      by Economic Logician in Economic Logic on 2011-12-27 21:27:00

    More about this item

    Keywords

    Precautionary savings; Saving; risk aversion; prudence; preferences; capital markets; international capital markets; world capital markets; International Finance: General; Open Economy Macroeconomics;

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