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Risky Income, Life Cycle Consumption, and Precautionary Savings

  • Jonathan S. Skinner

This paper argues that precautionary savings against uncertain income comprise a large fraction of aggregate savings. A closed-form approximation for life cycle consumption subject to uncertain interest rates and earnings is derived by taking a second-order Taylor-Series approximation of the Euler equations. Using empirical measures of income uncertainty, I find that precautionary savings comprises up to 56 percent of aggregate life cycle savings. The derived expression for n-period optimal consumption is easily implemented for econometric estimation, and accords well with the exact numerical solution. Empirical comparisons of savings patterns among occupational groups using the Consumer Expenditure Survey contradict the predictions of the life cycle model. Riskier occupations, such as the self-employed and salespersons, save less than other occupations, although this finding may in part reflect unobservable differences in risk aversion among occupations.

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File URL: http://www.nber.org/papers/w2336.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2336.

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Date of creation: Aug 1987
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Publication status: published as Journal of Monetary Economics, September 1988, vol 22, pp. 237-255.
Handle: RePEc:nbr:nberwo:2336
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  23. Sibley, David S., 1975. "Permanent and transitory income effects in a model of optimal consumption with wage income uncertainty," Journal of Economic Theory, Elsevier, vol. 11(1), pages 68-82, August.
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  26. Stephen Zeldes, . "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," Rodney L. White Center for Financial Research Working Papers 20-86, Wharton School Rodney L. White Center for Financial Research.
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