IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Rules of thumb in life-cycle savings models

  • Rodepeter, Ralf

    (Sonderforschungsbereich 504)

  • Winter, Joachim

    ()

    (Mannheim Research Institute for the Economics of Aging (MEA))

We analyze life-cycle savings decisions when households use simple heuristics, or rules of thumb, rather than solve the underlying intertemporal optimization problem. The decision rules we explore are a simple Keynesian rule where consumption follows income; a simple consumption rule where only a fraction of positive income shocks is saved; a rule that corresponds to the permanent income hypothesis; and two rules that have been found in experimental studies. Using these rules, we simulate life-cycle savings decisions numerically and compute the utility losses relative to the backwards solution of the intertemporal optimization problem. Our central finding is that the utility losses induced by rule-of-thumb behavior are relatively low. We conclude that behaving optimally, in the sense of solving an intertemporal optimization model, is not only costly, it is also not much better than using simple heuristics. Our results might also explain why optimization models typically fit the main features of empirical data quite well although optimizing behavior itself is frequently rejected.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sfb504.uni-mannheim.de/publications/dp99-81.pdf
Download Restriction: no

Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 99-81.

as
in new window

Length: 30 pages
Date of creation: 01 Oct 1999
Date of revision:
Handle: RePEc:xrs:sfbmaa:99-81
Note: Financial Support from Deutsche Forschungsgemeinschaft, SFB 504 at the University of Mannheim, is gratefully acknowledged.
Contact details of provider: Postal:
D-68131 Mannheim

Phone: (49) (0) 621-292-2547
Fax: (49) (0) 621-292-5594
Web page: http://www.sfb504.uni-mannheim.de/
Email:


More information through EDIRC

Web page: http://www.sfb504.uni-mannheim.de

Order Information: Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Campbell, John Y & Mankiw, N Gregory, 1990. "Permanent Income, Current Income, and Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 265-79, July.
  2. John H. Cochrane, 1988. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," NBER Working Papers 2730, National Bureau of Economic Research, Inc.
  3. Deaton, Angus, 1992. " Household Saving in LDCs: Credit Markets, Insurance and Welfare," Scandinavian Journal of Economics, Wiley Blackwell, vol. 94(2), pages 253-73.
  4. Martin Browning & Annamaria Lusardi, 1995. "Household Saving: Micro Theories and Micro Facts," Department of Economics Working Papers 1995-02, McMaster University.
  5. Christopher D Carroll, 1990. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," Economics Working Paper Archive 371, The Johns Hopkins University,Department of Economics, revised Aug 1996.
  6. Krusell, Per & Smith, Anthony Jr., 1996. "Rules of thumb in macroeconomic equilibrium A quantitative analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 20(4), pages 527-558, April.
  7. Ingram, Beth Fisher, 1990. "Equilibrium Modeling of Asset Prices: Rationality versus Rules of Thumb," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 115-25, January.
  8. Rodepeter, Ralf & Winter, Joachim, 1998. "Savings decisions under life-time and earnings uncertainty : empirical evidence from West German household data," Papers 98-58, Sonderforschungsbreich 504.
  9. Glaeser, Edward L. & Paulson, Anna L., 1997. "A reconsideration of the (in)sensitivity of tests of the intertemporal allocation of consumption to near rational alternatives," Journal of Economic Dynamics and Control, Elsevier, vol. 21(7), pages 1173-1180, June.
  10. Hey, John D & Dardanoni, Valentino, 1987. "Optimal Consumption under Uncertainty: An Experimental Investigation," Economic Journal, Royal Economic Society, vol. 98(390), pages 105-16, Supplemen.
  11. Deaton, A., 1989. "Saving And Liquidity Constraints," Papers 153, Princeton, Woodrow Wilson School - Public and International Affairs.
  12. Matthew Rabin., 1997. "Psychology and Economics," Economics Working Papers 97-251, University of California at Berkeley.
  13. G. Ellison & D. Fudenberg, 2010. "Rules of Thumb for Social Learning," Levine's Working Paper Archive 435, David K. Levine.
  14. John D. Hey, 2005. "Do People (Want To) Plan?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 52(1), pages 122-138, 02.
  15. Rust, J., 1994. "How Social Security and Medicare Affect Retirement Behavior in a World of Incomplete Markets," Working papers 9430, Wisconsin Madison - Social Systems.
  16. Shefrin, Hersh M & Thaler, Richard H, 1988. "The Behavioral Life-Cycle Hypothesis," Economic Inquiry, Western Economic Association International, vol. 26(4), pages 609-43, October.
  17. Rodepeter, Ralf & Winter, Joachim, 1998. "Savings decisions under life-time and earnings uncertainty:," Sonderforschungsbereich 504 Publications 98-58, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  18. Pemberton, James, 1993. "Attainable Non-optimality or Unattainable Optimality: A New Approach to Stochastic Life Cycle Problems: Erratum," Economic Journal, Royal Economic Society, vol. 103(419), pages 992-93, July.
  19. Milton Friedman, 1957. "Introduction to "A Theory of the Consumption Function"," NBER Chapters, in: A Theory of the Consumption Function, pages 1-6 National Bureau of Economic Research, Inc.
  20. 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.
  21. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  22. Harald Uhlig & Martin Lettau, 1999. "Rules of Thumb versus Dynamic Programming," American Economic Review, American Economic Association, vol. 89(1), pages 148-174, March.
  23. Stephen P. Zeldes, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 275-298.
  24. Laibson, David, 1998. "Life-cycle consumption and hyperbolic discount functions," European Economic Review, Elsevier, vol. 42(3-5), pages 861-871, May.
  25. Hindy, Ayman & Huang, Chi-fu & Zhu, Steven H., 1997. "Optimal consumption and portfolio rules with durability and habit formation," Journal of Economic Dynamics and Control, Elsevier, vol. 21(2-3), pages 525-550.
  26. Thaler, Richard H, 1994. "Psychology and Savings Policies," American Economic Review, American Economic Association, vol. 84(2), pages 186-92, May.
  27. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  28. McFadden, Daniel, 1999. "Rationality for Economists?," Journal of Risk and Uncertainty, Springer, vol. 19(1-3), pages 73-105, December.
  29. Herbert A. Simon, 1955. "A Behavioral Model of Rational Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 69(1), pages 99-118.
  30. Colin Camerer, 1998. "Bounded Rationality in Individual Decision Making," Experimental Economics, Springer, vol. 1(2), pages 163-183, September.
  31. Shi, Shouyong & Epstein, Larry G, 1993. "Habits and Time Preference," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 61-84, February.
  32. Pemberton, James, 1993. "Attainable Non-optimality or Unattainable Optimality: A New Approach to Stochastic Life Cycle Problems," Economic Journal, Royal Economic Society, vol. 103(416), pages 1-20, January.
  33. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1.
  34. Caballero, Ricardo J., 1990. "Consumption puzzles and precautionary savings," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 113-136, January.
  35. Loewenstein, George & Thaler, Richard H, 1989. "Intertemporal Choice," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 181-93, Fall.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:xrs:sfbmaa:99-81. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Carsten Schmidt)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.