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Non-expected Utility, Saving, and Portfolios

  • Michael Haliassos

    (The University of Cyprus)

  • Christis Hassapis

    (The University of Cyprus)

Existing findings suggest that standard, frictionless, expected-utility models have difficulty accounting for average and for median holdings of wealth and of risky assets, partly as a result of the largely unexplained limited proportion of stockholders among households. We analyze life-cycle wealth accumulation and portfolio choice under career uncertainty and quantifiable departures from expected utility maximization. Our specification nests expected utility and three types of non-expected utility: (i) Kreps-Porteus preferences that disentangle risk aversion from elasticity of substitution, (ii) Yaari's Dual Theory of Choice, and (iii) Quiggin's Rank-dependent Utility. Specifications (ii) and (iii) exhibit "first-order" risk aversion and kinked indifference curves. Solution of such models under multiple sources of risk presents conceptual and computational difficulties. We introduce a notion of equilibrium and a computational algorithm appropriate for such setups. Computed wealth and stockholding, based on calibrated income processes for three education categories, are compared to the 1992 Survey of Consumer Finances. Rank-dependent utility enhances the importance of precautionary effects. Contrary to priors in the literature, solutions are not typically at kinks; neither kinks nor actual solutions involve zero stockholding when income risk is recognized; and yet predictions about average wealth and risky assets tend to improve for all education categories. Mere disentangling of risk aversion from elasticity has small effects, while dual theory predictions are farther from the data and the signs of precautionary effects are reversed.

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File URL: http://econwpa.repec.org/eps/mac/papers/9709/9709003.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 9709003.

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Date of creation: 30 Sep 1997
Date of revision: 11 Apr 1998
Handle: RePEc:wpa:wuwpma:9709003
Note: Type of Document - acrobat.pdf; figures: included
Contact details of provider: Web page: http://econwpa.repec.org

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  1. James M. Poterba & Andrew A. Samwick, 1995. "Stock Ownership Patterns, Stock Market Fluctuations, and Consumption," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 295-372.
  2. Bertaut, Carol C. & Haliassos, Michael, 1997. "Precautionary portfolio behavior from a life-cycle perspective," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1511-1542, June.
  3. George M. Constantinides & John B. Donaldson & Rajnish Mehra, 2002. "Junior Can'T Borrow: A New Perspective On The Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 269-296, February.
  4. Zeldes, Stephen P, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 275-98, May.
  5. Michael Haliassos & Christis Hassapis, 1999. "Borrowing Constraints, Portfolio Choice and Precautionary Motives: Theoretical Predictions and Empirical Complications," Computing in Economics and Finance 1999 1341, Society for Computational Economics.
  6. Hubbard, R. Glenn & Skinner, Jonathan & Zeldes, Stephen P., 1994. "The importance of precautionary motives in explaining individual and aggregate saving," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 40(1), pages 59-125, June.
  7. Uzi Segal & Avia Spivak, 1988. "First Order Versus Second Order Risk Aversion," UCLA Economics Working Papers 540, UCLA Department of Economics.
  8. Orazio P. Attanasio & James Banks & Sarah Tanner, 2002. "Asset Holding and Consumption Volatility," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 771-792, August.
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  10. Mankiw, N.G. & Zeldes, S.P., 1990. "The Consumption Of Stockholders And Non-Stockholders," Weiss Center Working Papers 23-90, Wharton School - Weiss Center for International Financial Research.
  11. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February.
  12. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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  16. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
  17. Mervyn A. King & Jonathan I. Leape, 1984. "Wealth and Portfolio Composition: Theory and Evidence," NBER Working Papers 1468, National Bureau of Economic Research, Inc.
  18. Miles S. Kimball, 1991. "Standard Risk Aversion," NBER Technical Working Papers 0099, National Bureau of Economic Research, Inc.
  19. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1994. "Income Risk, Borrowing Constraints and Portfolio Choice," CEPR Discussion Papers 888, C.E.P.R. Discussion Papers.
  20. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  21. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  22. Haliassos, Michael & Bertaut, Carol C, 1995. "Why Do So Few Hold Stocks?," Economic Journal, Royal Economic Society, vol. 105(432), pages 1110-29, September.
  23. Attanasio, Orazio P & Weber, Guglielmo, 1989. "Intertemporal Substitution, Risk Aversion and the Euler Equation for Consumption," Economic Journal, Royal Economic Society, vol. 99(395), pages 59-73, Supplemen.
  24. Finn E. Kydland & Edward C. Prescott, 1996. "The Computational Experiment: An Econometric Tool," Journal of Economic Perspectives, American Economic Association, vol. 10(1), pages 69-85, Winter.
  25. Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
  26. Haliassos, Michael, 1994. "On Perfect Foresight Models of a Stochastic World," Economic Journal, Royal Economic Society, vol. 104(424), pages 477-91, May.
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