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Income Risk, Precautionary Saving, and Loss Aversion – An Empirical Test

Marcela Ibanez () and Sebastian Schneider
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Marcela Ibanez: University of Goettingen

No 2023_06, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: This paper empirically examines the behavioral precautionary saving hypothesis by Koszegi and Rabin (2009) stating that uncertainty about future income triggers saving because of loss aversion. We extend their theoretical analysis to also consider the internal margin, i.e., the strength, of loss aversion, and empirically study the relation between income risk, experimentally elicited loss aversion and precautionary savings. We do so using a sample of 640 individuals from the low-income population of Bogotá, characterized by limited financial education and subject to substantial income risk. In line with the theoretical predictions, we find that an increase in income risk is associated with higher savings for loss-averse individuals, and that this increase in savings grows with the degree of loss aversion. Thus, as suggested by Koszegi and Rabin (2009), but contrarily to common assumptions, our findings establish that loss aversion is not necessarily an obstacle to saving, and thus identify new approaches of increasing saving among individuals with low financial education.

Keywords: Reference-dependent utility; expectations; consumption plans; precautionary savings; loss aversion; risk preferences; income risk; low-income; Bogotá; experiment (search for similar items in EconPapers)
JEL-codes: D11 D14 D15 D81 D90 G40 J65 O16 (search for similar items in EconPapers)
Date: 2021-03-04, Revised 2023-06-28
New Economics Papers: this item is included in nep-exp, nep-fle and nep-upt
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