Open AccessRisk-Sensitive Consumption and Savings under Rational Inattention
Author(s) -
Yulei Luo,
Eric R. Young
Publication year - 2010
Publication title -
american economic journal macroeconomics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 10.443
H-Index - 61
eISSN - 1945-7707
pISSN - 1945-7715
DOI - 10.1257/mac.2.4.281
Subject(s) - observational equivalence , consumption (sociology) , robustness (evolution) , economics , equivalence (formal languages) , sensitivity (control systems) , welfare , econometrics , microeconomics , precautionary savings , range (aeronautics) , mathematics , monetary economics , engineering , discrete mathematics , market liquidity , market economy , social science , biochemistry , chemistry , electronic engineering , sociology , gene , aerospace engineering
This paper studies the consumption-savings behavior of households who have risk-sensitive preferences and suffer from limited information-processing capacity (rational inattention or RI). We first solve the model explicitly and show that RI increases precautionary savings by interacting with income uncertainty and risk sensitivity. Given the closed-form solutions, we find that the RI model displays a wide range of observational equivalence properties, implying that consumption and savings data cannot distinguish between risk sensitivity, robustness, or the discount factor, in any combination. We then show that the welfare costs from RI are larger for risk-sensitive households than any other observationally-equivalent settings. (JEL D11, D81, D82, E13, E21
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