Precautionary Savings Motives Research Articles

The Time‐Varying Volatility of Earnings and Aggregate Consumption Growth

Time‐varying specifications for the conditional variance of earnings of U.S. households are estimated with micro data over the period 1968–92. The cross‐sectional mean of the estimated time‐varying uncertainty of individual households has a significant impact on aggregate consumption growth. As such, aggregate precautionary savings may be more important than what is suggested by the results of estimating standard regression equations for aggregate consumption growth that incorporate only lagged income growth and the real interest rate. The estimation of a buffer stock consumption model with time‐varying earnings uncertainty suggests that the precautionary savings motive is cyclical and has become less important in the 1980s.

Estimating the elasticity of intertemporal substitution taking into account the precautionary savings motive

This paper estimates the elasticity of intertemporal substitution for U.S. aggregate time series data, taking into account the precautionary savings motive. By making use of a recursive utility function, we estimate an Euler equation, via GMM. This procedure leads consumption growth rate to depend on asset returns, and on a time-varying variance, which captures the precautionary motive. When significant, the elasticity of intertemporal substitution estimates ranges from 0.4 to 1.8, which are higher than most of the results found in the literature. Furthermore, the evidence suggests that consumers react to risk; however, the contribution of precautionary motive to consumption growth seems to be limited.

External Habit in a Production Economy: A Model of Asset Prices and Consumption Volatility Risk

A standard real business cycle model with external habit and capital adjustment costs matches a long list of asset price and business cycle moments: equity, firm value, and risk-free rate volatility; the equity premium; excess return predictability; consumption growth predictability; basic moments of consumption, output, and investment; and more. The model also generates endogenous consumption volatility risk. Precautionary savings motives make consumption sensitive to shocks in bad times, leading to countercyclical volatility, even with homoskedastic technology shocks. Habit acts as countercyclical leverage, which amplifies this channel. Habit also implies high risk aversion, which amplifies the stock price response.

Bequest Motives and the Demand for Life Insurance in East Germany

AbstractEmpirical studies of household saving remain inconclusive about the role of bequest motives. This may be due to the diluting effect of different tax regimes across countries and time on estimates of bequest motives. Relative to market-based economies, the former German Democratic Republic can be viewed as an experimental institutional setting where life-insurance demand was not influenced by tax considerations. This allows isolating bequest motives from other life-cycle and precautionary savings motives. Analyzing the demand for life insurance, we find a significantly higher ownership probability among households with children and a high regard for the family, confirming bequest motives in life-insurance demand.

International Capital Flows, External Assets and Output Volatility

This paper proposes a new perspective on international capital flows and countries' long-run external asset position. Cross-sectional evidence for 84 developing countries shows that over the last three decades countries that have had on average higher volatility of output growth (1) accumulated higher external assets in the long-run and (2) experienced more procyclical capital outflows over the business cycle than those countries with a same growth rate but a more stable output path. To explain this finding we provide a theoretical mechanism within a stochastic real business cycle growth model in which higher uncertainty of the income stream increases the precautionary savings motive of households. They have a desire to save more when the variance of their expected income stream is higher. We show that in the model the combination of income risk and a precautionary savings motive will lead to procyclical capital outflows at business cycle frequency and a higher long-run external asset position.

Consumption Utility-Based Pricing of Contingent Convertible Bonds and Optimal Capital Structure

We consider the utility-based pricing of corporate securities and optimal capital structure including contingent convertible bond (CCB). We derive the semi-closed-form solutions of the implied values of corporate securities without bankruptcy costs and taxes. Our numerical simulations show that CCB is able to increase the value of the issued firm while it also leads to a less bankruptcy risk. The higher the business risk or the more risk-averse the buyers are, the more (less) the CCB (straight bond) should be issued. Our model explicitly finds that a straight bond will decrease the implied value of equity by strengthening precautionary savings motive of the equity holder, but on the contrary, CCB will increase the implied value by weakening this motive. This is a hidden merit of CCB, which is overlooked in a risk-neutral world.

Decomposition of effects of social security on private savings

AbstractThe main aim of this paper is to decompose the effects of social security on private savings and quantify to what extent each factor that impacts saving behavior account for the effects of social security. For this purpose, I estimate a stochastic dynamic model in which households facing income and survival uncertainty choose optimal levels of consumption, asset holdings and labor supply. In this model, social security pensions reduce private assets by less than 10%. Bequest and precautionary savings motives are the main reasons of this partial offset. Uncertainty on future benefits has no role to play on the effect.

Precautionary Savings in the Great Recession

Heightened uncertainty since the onset of the Great Recession has materially increased saving rates, contributing to lower consumption and GDP growth. Consistent with a model of precautionary savings in the face of uncertainty, the paper finds for a panel of advanced economies that greater labor income uncertainty is significantly associated with higher household savings. These results are robust to controlling for other determinants of saving rates, including wealth-to-income ratios, the government fiscal balance, demographics, credit conditions, and global growth and financial stress. The estimates imply that at least two-fifths of the sharp increase in household saving rates between 2007 and 2009 can be attributed to the precautionary savings motive.

The Precautionary Savings Motive and Household Savings

We quantified the relative importance of the precautionary motive in determining savings. Existing empirical evidence suggests that the impact of precautionary savings is small if one uses a subjective measure of uncertainty about next year income. However, other studies use an ‘objective’ method to proxy for income uncertainty by exploiting life-cycle income variation. These studies find a large impact of precautionary savings. These contradictory results may be either suggestive of methodological shortcomings or the result of institutional differences between countries. We refined the subjective method by taking into account the uncertainty as perceived by the second income earner. We then apply the ‘objective’ and ‘subjective’ method to the same dataset and obtain similar results: the subjective and objective methods suggest that precautionary savings account for approximately 30% of savings. Obtaining converging results does not necessarily determine the empirical relevance of precautionary savings if studies from different countries are compared.

Time-Varying Oil Price Volatility and Macroeconomic Aggregates

We illustrate the theoretical relation among output, consumption, investment, and oil price volatility in a real business cycle model. The model incorporates demand for oil by a firm, as an intermediate input, and by a household, used in conjunction with a durable good. We estimate a stochastic volatility process for the real price of oil over the period 1986-2011 and utilize the estimated process in a non-linear approximation of the model. For realistic calibrations, an increase in oil price volatility produces a temporary decrease in durable spending, while precautionary savings motives lead investment and real GDP to rise. Irreversible capital and durable investment decisions do not overturn this result.

Time-Varying Oil Price Volatility and Macroeconomic Aggregates

We illustrate the theoretical relation among output, consumption, investment, and oil price volatility in a real business cycle model. The model incorporates demand for oil by a firm, as an intermediate input, and by a household, used in conjunction with a durable good. We estimate a stochastic volatility process for the real price of oil over the period 1986-2011 and utilize the estimated process in a non-linear approximation of the model. For realistic calibrations, an increase in oil price volatility produces a temporary decrease in durable spending, while precautionary savings motives lead investment and real GDP to rise. Irreversible capital and durable investment decisions do not overturn this result.

Precautionary Savings in the Great Recession

Heightened uncertainty since the onset of the Great Recession has materially increased saving rates, contributing to lower consumption and GDP growth. Consistent with a model of precautionary savings in the face of uncertainty, we find for a panel of advanced economies that greater labor income uncertainty is significantly associated with higher household savings. These results are robust to controlling for other determinants of saving rates, including wealth-to-income ratios, the government fiscal balance, demographics, credit conditions, and global growth and financial stress. Our estimates imply that at least two-fifths of the sharp increase in household saving rates between 2007 and 2009 can be attributed to the precautionary savings motive.

The Consumption Response to Seasonal Income: Evidence from Japanese Public Pension Benefits

Japanese public pension benefits, which were distributed quarterly through February 1990, and every other month since then, induce substantial but predictable income fluctuations. The relative magnitude of the payments combined with the delay between payments yields a stronger test of the Life-Cycle/Permanent Income Hypothesis than in prior studies. Applying two identification strategies to monthly household panel data, we find that consumption significantly responds to quarterly benefit receipt. Additional analysis suggests that our findings cannot be explained by either liquidity constraints or precautionary savings motives. (JEL D12, D91, E21, H55)

Incomplete markets, labor supply and capital accumulation

Endogenous labor supply decisions are introduced in an equilibrium model of limited insurance against idiosyncratic shocks. Unlike in the standard case with exogenous labor (e.g. [Aiyagari, S.R., 1994. Uninsured idiosyncratic risk and aggregate saving. Quarterly Journal of Economics 109, 659–684; Huggett, M., 1997. The one-sector growth model with idiosyncratic shocks: steady states and dynamics. Journal of Monetary Economics 39, 385–403]), labor supply is likely to be lower than under complete markets. This is due to an ex post wealth effect on labor supply (rich productive agents work fewer hours) that runs counter the precautionary savings motive. As a result, equilibrium savings and output may be lower under incomplete markets. It is also found that long-run savings remain finite even when the interest rate equals the inverse of the discount factor.

WELFARE GAINS FROM STABILIZATION IN A STOCHASTICALLY GROWING ECONOMY WITH IDIOSYNCRATIC SHOCKS AND FLEXIBLE LABOR SUPPLY

Stochastic models with economywide shocks imply that the welfare costs of aggregate volatility are negligible. Empirical evidence suggests that the volatility of idiosyncratic shocks is several times that of aggregate shocks. This paper introduces both types of shocks. We find that if in the process of eliminating aggregate risk the policymaker can reduce idiosyncratic risk by an amount suggested by available empirical evidence, the welfare gains from stabilization can become significant. The introduction of idiosyncratic risk has important implications for asset pricing, and in particular may reduce the risk-free rate substantially, through the precautionary savings motive. Many of our results are sensitive both to the degree of risk aversion and to the flexibility of labor supply. The paper highlights the trade-offs involved in analyzing the effects of risk on growth and welfare and on asset pricing, clarifying the need to examine these issues within a unified stochastic general equilibrium framework.

Precautionary Savings Motives and Tax Efficiency of Household Portfolios: An Empirical Analysis

Tax efficiency is the dominant consideration in theoretical portfolio models that allow for both taxable and tax-deferred accounts (TDAs). Investors are advised to locate higher-tax assets in their tax-deferred accounts, which in the Unites States commonly translates into holding bonds inside TDAs and holding equities outside. Yet, observed portfolio allocations are not tax efficient. This paper empirically evaluates the predictions of a recent model designed to bridge the existing gap by explicitly incorporating uninsurable labor income risk and limited accessibility of TDA assets in household decisions [Amromin, 2003]. Together, these elements create tension between household's desire to maintain tax efficient allocations and its concern over the need to make costly TDA withdrawals in the event of bad income draws. This leads some borrowing-constrained households facing labor income risk and TDA access penalties to forgo tax efficiency in favor of allocations that provide more liquidity in bad income states - an outcome labeled as precautionary portfolio choice. The empirical results based on household-level portfolio data from the Survey of Consumer Finances provide evidence that both the choice of whether to hold a tax efficient portfolio and the degree of portfolio tax inefficiency are related to the presence and severity of precautionary motives.

Precautionary Savings Motives and Tax Efficiency of Household Portfolios: An Empirical Analysis

Tax efficiency is the dominant consideration in theoretical portfolio models that allow for both taxable and tax-deferred accounts (TDAs). Investors are advised to locate higher-tax assets in their tax-deferred accounts, which in the Unites States commonly translates into "holding bonds inside TDAs and holding equities outside." Yet, observed portfolio allocations are not tax efficient. This paper empirically evaluates the predictions of a recent model designed to bridge the existing gap by explicitly incorporating uninsurable labor income risk and limited accessibility of TDA assets in household decisions [Amromin, 2003]. Together, these elements create tension between household's desire to maintain tax efficient allocations and its concern over the need to make costly TDA withdrawals in the event of bad income draws. This leads some borrowing-constrained households facing labor income risk and TDA access penalties to forgo tax efficiency in favor of allocations that provide more liquidity in bad income states--an outcome labeled as "precautionary portfolio choice." The empirical results based on household-level portfolio data from the Survey of Consumer Finances provide evidence that both the choice of whether to hold a tax efficient portfolio and the degree of portfolio tax inefficiency are related to the presence and severity of precautionary motives.

Caballero Meets Bewley: The Permanent-Income Hypothesis in General Equilibrium

The permanent-income hypothesis (PIH) of Milton Friedman (1957) states that the agent saves in anticipation of possible future declines in labor income (John Y. Campbell, 1987). He also saves for precautionary reasons, and dissaves because of impatience. To justify the PIH in an intertemporal optimization framework, it has been conventional to assume both (i) quadratic utility, to turn off precautionary motives (Robert E. Hall, 1978), and (ii) equality between the subjective discount rate and the interest rate, in order to rule out dissavings for lack of patience. Neither assumption is plausible. Much work on consumption in the past decade has focused on individual’s precautionary savings motives and liquidity constraints. Impatience is a standard result in heterogeneousagents general-equilibrium incomplete-markets models, generally known as Bewley models. This paper shows that the PIH is in any case the optimal rule, in a Bewley model, in which each agent solves the precautionary-savings model of Caballero (1990, 1991). In addition to the demand for savings for a “rainy day,” Caballero’s model also predicts a constant precautionary-savings demand and constant dissavings due to impatience. In equilibrium, I show that these two forces must cancel each other. As a result, the agent behaves in accordance with the PIH. Section I describes the model. Section II concludes. The Appendix provides a heuristic derivation and a proof of the optimal consumption rule.

Household Savings in the Transition

We explore household savings decision in Bulgaria, Hungary, and Poland during the transition from plan to market, finding four main results. First, except for the age profile, the effects of standard determinants on savings are comparable for transition and market economies. Second, we do not find support for a precautionary savings motive. Third, the evidence on consumption smoothing is mixed. Education of the head of the household, but not employment characteristics, are linked robustly to savings. Fourth, ownership of durables is negatively correlated with savings, consistent with the presence of anticipatory savings. J. Comp. Econ., September 2002 30(3), pp. 463–475. The World Bank, 1818 H Street N.W., Washington, DC 20433; Center for German and European Studies, Georgetown University, Washington, DC 20057; and Oxford University Oxford, England OX1 2RL, United Kingdom. © 2002 Association for Comparative Economic Studies. Published by Elsevier Science (USA). All rights reserved. Journal of Economic Literature Classification Numbers: D12, D31, D91, O16, P36.

For Better or for Worse? State-Level Marital Formation and Risk Sharing

Why do some U.S. states have higher levels of marital formation than others? This paper introduces an economic model wherein a state's representative individual may choose to marry in order to diversify his or her idiosyncratic income risk. The paper demonstrates that such a diversification motive is enhanced for some utility functions when a state's level of undiversifiable risk becomes larger, and when a state's initial income and growth rate is lower. A test of the model's predictions, using cross-sectional data for the 50 U.S. states, suggests that there is broad support for a risk-sharing motive for marriage as well as for a precautionary savings motive.