Optimistic about the future? How uncertainty and expectations about future consumption prospects affect optimal consumer behavior

Johnson Kakeu and Byron Sharri
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Byron Sharri: Drew University, 36 Madison Avenue, Madison, New Jersey 07940, USA

The B.E. Journal of Macroeconomics, 2016, vol. 16, issue 1, 171-192

Abstract: This paper analyzes a continuous time stochastic growth model with a Duffie and Epstein (Duffie, D., and L. Epstein. 1992. “Stochastic Differential Utility.” Econometrica 60: 353–394.) recursive utility. We find that optimal consumption decisions are determined in a non trivial way by factors such as changes in expectations about future prospects (sentiment), and a matrix of weights that expresses the sensitivity of the consumer to a global macroeconomic risk. The weighting matrix can also be thought of as a measure of multivariate prudence.The sentiment channel is governed by two forces working in opposite directions; one is related to the consumer’s aversion to long-run risk and the other is related to the consumer’s aversion to short-run risk. The greater is the aversion to long-run risk relative to the aversion to short-run risk, the higher is the magnitude of the sentiment effect. This suggests a linkage between the sentiment effect and temporal risk attitudes.

Keywords: aversion to long-run risk; aversion to short-run risk; continuous-time stochastic recursive utility; endogenous growth model; sentiment about the future; sentiment effect (search for similar items in EconPapers)
JEL-codes: D81 D9 E2 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (2)

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DOI: 10.1515/bejm-2014-0155

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