Precautionary Savings in a Small Open Economy Revisited
IMF Working Papers, November 1, 2011
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Bibliographic details
- Authors: Agustin Roitman
- Published: November 1, 2011
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781463923358.001
Summary
- A common assumption in standard economic models is that agents are risk-averse and prudent, and it is often argued that prudence is necessary to generate precautionary savings.
- This paper shows that prudence is not necessary to generate precautionary savings in small open economy models with more than two periods.
- A new class of preferences, which enables the isolation of the effect of risk aversion on precautionary savings, is introduced.
- The effects of changes in risk aversion, interest rates, and persistence and volatility of shocks on average asset holdings are qualitatively identical to the ones observed for standard constant-elasticity-of-substitution preferences.
- These results show that the almost universal assertion in the literature — that only prudent consumers can generate positive levels of precautionary savings — is simply incorrect.
Main findings
- Prudence is not necessary for positive precautionary savings in small open economy models with more than two periods.
- Introducing a new class of preferences allows isolation of the effect of risk aversion on precautionary savings.
- Effects of changes in:
- risk aversion,
- interest rates,
- persistence of shocks, and
- volatility of shocks
on average asset holdings are qualitatively identical to those observed under standard constant-elasticity-of-substitution preferences.
Methodology and scope
- Context: small open economy models with more than two periods.
- Modeling innovation: a new class of preferences designed to isolate risk aversion effects from prudence.
- Comparative benchmark: standard constant-elasticity-of-substitution (CES) preferences.
Implications for theory and modeling
- Challenges the near-universal claim in the literature that only prudent consumers can generate positive precautionary savings.
- Suggests robustness of qualitative relationships between risk aversion, interest rates, shock persistence/volatility, and average asset holdings across different preference specifications.