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Extra resources for 2008 Schweser QuickSheet: Critical Concepts for Exam Success. Level 2

Example text

This is the approach taken in a number of studies, such as those of Skinner (1988), Zeldes (1989b), Deaton (1991), Carroll (1994) and Hubbard, Skinner and Zeldes (1994, 1995). A disturbing feature of these studies is that the quantitative importance of the precautionary motive depends crucially on the properties of the distribution of the income process in the left tail. Bounding away the income process from zero (or from arbitrarily small realisations) greatly reduces the precautionary motive.

P. Attanasio (i) Equation (4) assumes that utility is separable over time. This is a strong assumption and rules out at least two important phenomena: habit formation and durable commodities. The marginal utility o f consumption in any given time period does not depend on consumption expenditure in any other period. We also assume that expenditure coincides with consumption. One obvious possibility to rationalise this model without excluding the existence o f durables is to assume that the instantaneous utility function is additively separable in non-durables and in the services provided by durables.

Attanasio 778 Given these considerations, it is important, especially if one wants to bring the model to the data, to consider a specification that allows for these factors. While it is true, as shown in Section 2, that consumption life cycle profiles often mirror income profiles, it is not obvious that one should interpret this as evidence of the empirical failure of the model without considering explicitly the possibility of important demographic effects and that consumption and leisure are not separable.

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