Precautionary Saving: An Explanation for Excess Smoothness of Consumption

Michel Normandin ()

No 4, Cahiers de recherche CREFE / CREFE Working Papers from CREFE, Université du Québec à Montréal

Abstract: The permanent income hypothesis under certainty equivalence implies that optimal consumption is more volatile than labour income, when labour income is positively autocorrelated in first differences. Empirically, certainty equivalence is rejected because observed consumption is excessively smooth. One approach to account for excess smoothness is to relax certainty equivalence by using utility functions which induce precautionary saving. This paper analyzes a hyperbolic absolute risk aversion utility function. Some reasonable parametrizations of this specification imply that consumption is smoother than labour income and that the relative smoothness matches the data.

L'hypothèse de revenu permanent en équivalence certaine implique que la consommation optimale est plus variable que le revenu de travail lorsque ce dernier est positivement autocorrélé en première différence. Empiriquement, l'équivalence certaine est rejetée parce que la consommation observée est excessivement lisse. Une stratégie visant à expliquer le lissage excessif consiste à relâcher la propriété d'équivalence certaine afin de considérer l'épargne de précaution. Ce papier analyse l'épargne de précaution découlant d'une fonction d'utilité dont l'aversion absolue au risque est hyperbolique. Certaines spécifications raisonnables de cette fonction impliquent que la consommation est plus lisse que le revenu de travail et que le lissage relatif réplique celui observé.

Keywords: precautionary savings; excess smoothness; numerical solutions; exact inference (search for similar items in EconPapers)
JEL-codes: E21 (search for similar items in EconPapers)
Pages: 32 pages
Date: 1992-10
References: Add references at CitEc
Citations: View citations in EconPapers (1)

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