Excess sensitivity of consumption to income growth: a model of Loss Aversion *

Giacomo Pasini

Industrial and Corporate Change, 2009, vol. 18, issue 4, 575-594

Abstract: The article provides an empirical test on micro-data of a model of individual behavior based on Loss Aversion: utility is S-shaped, i.e. concave above reference consumption and convex below it. As a consequence individuals do not reduce current consumption in response to an expected income decline as long as uncertainty is high enough. Such a behavior is consistent with excess sensitivity of consumption to income growth, an empirical regularity which is hard to explain within a standard Life Cycle model. Loss Aversion is tested on an Italian dataset (the Bank of Italy's; Survey on Households' Income and Wealth). The conclusion is that excess sensitivity could be explained by a model that do not assume individuals to be expected utility maximizers. Copyright 2009 , Oxford University Press.

Date: 2009
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