A Closed-form Solution for a Model of Precautionary Saving

Frederick (Rick) van der Ploeg

The Review of Economic Studies, 1993, vol. 60, issue 2, 385-395

Abstract: This paper analyses life-cycle consumption plans and distinguishes between temporal risk aversion and intertemporal substitution. The results assume that felicity functions are quadratic and that income follows a linear model with normally distributed errors. Stochastic dynamic programming then yields closed-loop linear decision rules. Certainty equivalence no longer holds, but instead households play a min-max strategy against nature. One finds a rationale for precautionary saving and a larger sensitivity of changes in consumption to income innovations.

Date: 1993
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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:60:y:1993:i:2:p:385-395.

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