The Volatility Trap : Precautionary Saving, Investment, and Aggregate Risk

Author/Editor:

Reda Cherif ; Fuad Hasanov

Publication Date:

May 1, 2012

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

We study the effects of permanent and temporary income shocks on precautionary saving and investment in a "store-or-sow" model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment, or a "volatility trap." Namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump-shaped function of the volatility of permanent shocks, as predicted by the model.

Series:

Working Paper No. 12/134

Subject:

English

Publication Date:

May 1, 2012

ISBN/ISSN:

9781475503869/1018-5941

Stock No:

WPIEA2012134

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

21

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