Optimal consumption with reference-dependent preferences in on-the-job search and savings

Abstract

This paper studies a model of on-the-job search and savings under reference-dependent preferences that implies loss aversion in a worker's consumption behaviors. The model analyzes how loss aversion affects the worker's consumption decisions in job search. The results demonstrate that the presence of loss aversion will lead to a set of high steady-state consumption levels and the range of steady-state consumption levels is wider if the worker is more loss averse. Nevertheless, we show that there is a unique steady-state consumption level, which is a lower bound of the set, in the absence of loss aversion. In addition, we also find that great loss aversion may reduce consumption level, while small loss aversion not only causes consumption to remain at a high level, but also induces that the worker's future consumption level goes down when the employment status changes.