Optimal consumption and savings with stochastic income
Abstract
We develop an analytically tractable consumption-savings model for a liquidity-constrained agent
who faces both permanent and transitory income shocks. We find that risk aversion and intertemporal
substitution have very different effects on both consumption and the steady-state savings target. Moderate
changes in risk aversion have large effects on consumption and buffer-stock savings. With permanent
shocks, it takes many years to reach the steady-state savings target. We also find that large discrete
income shocks (jumps) occurring at low frequencies can be very costly. Unlike conventional wisdom,
transitory shocks can generate very large precautionary savings demand, especially for low transitory
income states.
Description
NBER Working Paper No. 19319, August 2013, JEL No. E21
Rights
This publication is a work of the U.S. Government as defined in Title 17, United States Code, Section 101. Copyright protection is not available for this work in the United States.Collections
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