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Rules of thumb in life-cycle savings models

Ralf Rodepeter and Joachim Klaus Winter ()
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Ralf Rodepeter: Sonderforschungsbereich 504, Postal: L 13, 15, D-68131 Mannheim

No 99-81, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim

Abstract: 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.

New Economics Papers: this item is included in nep-dge, nep-evo, nep-exp and nep-mic
Date: 1999-10-01
Note: Financial Support from Deutsche Forschungsgemeinschaft, SFB 504 at the University of Mannheim, is gratefully acknowledged.
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Working Paper: Rules of Thumb in Life-Cycle Savings Models (2000) Downloads
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