Precautionary Savings and Self-Selection - Evidence from the German Reunification "Experiment"

Nicola Fuchs-Schundeln and Matthias Schundeln

No 2069, Harvard Institute of Economic Research Working Papers from Harvard - Institute of Economic Research

Abstract: We combine particular features of the German civil service with the unique event of German reunification to test the theory of precautionary savings and to quantify the importance of self-selection into occupations due to differences in risk aversion. In the presence of self-selection, failing to control for risk aversion in empirical tests of precautionary savings results in a bias that could lead to a false rejection of the theory. We exploit the fact that for individuals from the former German Democratic Republic (GDR) German reunification in 1990 caused an exogenous reassignment of income risks. Our findings suggest that self-selection of risk averse individuals into low-risk occupations is economically important and decreases aggregate precautionary wealth holdings significantly.

Date: Written 2005
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