Showing papers on "Precautionary savings published in 2012"

Cash Holdings and Credit Risk

Abstract: Intuition suggests that rms with higher cash holdings are safer and should have lower credit spreads. Yet empirically the correlation between cash and spreads is robustly positive, and higher for lower credit ratings. This puzzling nding can be explained by the precautionary motive for saving cash. In our model endogenously determined optimal cash reserves are positively related to credit risk, resulting in a spurious positive correlation between cash and spreads. By contrast, spreads are negatively related to the \exogenous" component of cash holdings independent of credit risk factors. Similarly, although rms with higher cash reserves are less likely to default over short horizons, longer term endogenously determined liquidity may be positively related to the probability of default. Our empirical analysis conrms these predictions, suggesting that endogenous precautionary savings are central to understanding the eects of cash on credit risk.

Precautionary Savings in the Great Recession

Abstract: 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.

Inequality and the life cycle

Abstract: I structurally estimate an incomplete markets life-cycle model with endogenous labor supply using data on the joint distribution of wages, hours, and consump- tion. The model is successful at matching the evolution of both the first and sec- ond moments of the data over the life cycle. The key challenge for the model is to generate declining inequality in annual hours worked over the first half of the working life, while respecting the constraints imposed by the data on consump- tion and wages. I argue that this is a robust feature of the data on life-cycle labor supply that is strongly at odds with the intratemporal first-order condition for la- bor. Allowing for a realistic degree of involuntary unemployment, coupled with preferences that feature nonseparability in the disutility of the extensive and in- tensive margins of hours worked, allows the model to overcome this challenge. The results imply that labor market frictions are important in jointly account- ing for observed cross-sectional inequality in labor supply and consumption, and may have quantitative relevance for analyses that exploit the intratemporal first- order condition for labor. Keywords. Inequality, life cycle, hours worked, intensive and extensive labor sup- ply, structural estimation, precautionary savings. JEL classification. C13, D21, E21, E24, J22.

Policy Uncertainty and Household Savings

Abstract: Using German microdata and a quasi-natural experiment, we provide evidence on how households respond to an increase in uncertainty. We find that household saving increases significantly following the increase in political uncertainty observed in the run-up to the 1998 German general election. We also find evidence of a labor supply response by workers who can use the margin offered by part-time employment. Our results are suggestive of the economic effects of “wars of attrition”: when political disagreement leads to delays in adopting a reform or the possibility that earlier reforms may be revoked, the increased uncertainty could slow the economy.

Under-Savers Anonymous: Evidence on Self-Help Groups and Peer Pressure as a Savings Commitment Device

Abstract: We test the effectiveness of self-help peer groups as a commitment device for precautionary savings, through two randomized field experiments among 2,687 microentrepreneurs in Chile The first experiment finds that self-help peer groups are a powerful tool to increase savings (the number of deposits grows 35-fold and the average savings balance almost doubles) Conversely, a substantially higher interest rate has no effect on most participants A second experiment tests an alternative delivery mechanism and shows that effects of a similar size can be achieved by holding people accountable through feedback text messages, without any meetings or peer pressure

Are optimistic expectations keeping the Chinese happy

Abstract: In this paper we study the effect of optimistic income expectations on life satisfaction amongst the Chinese population. Using a large scale household survey conducted in 2002 we find that the level of optimism about the future is particularly strong in the countryside and amongst rural-to-urban migrants. The importance of these expectations for life satisfaction is particularly pronounced in the urban areas, though also highly significant for the rural area. If expectations were to reverse from positive to negative, we calculate that this would have doubled the proportion of unhappy people and reduced proportion of very happy people by 48 per cent. We perform several robustness checks to see if the results are driven by variations in precautionary savings or reverse causality.

On relative and partial risk attitudes: theory and implications

Abstract: This paper develops context-free interpretations for the relative and partial Nth degree risk attitude measures and show that various conditions on theses measures are utility characterizations of the effects of scaling general stochastic changes in different settings. It is then shown that these characterizations can be applied to generalize comparative statics results in a number of important problems, including precautionary savings, optimal portfolio choice, and competitive firms under price uncertainty.

Precautionary Effort: A New Look

Abstract: While the concept of precautionary saving is well documented, that of precautionary effort has received relatively limited attention. In this note, we set up a two period model in order to analyze the conditions under which the introduction (or deterioration) of an independent background risk increases effort. INTRODUCTION Ehrlich and Becker's (1972) article initiated a very long research activity in economics around the notion of self-protection and its relationship with other risk management instruments. While many papers in economics still deal directly or indirectly on a regular basis with the topics, the discussion has spread over to other disciplines such as health management or environmental policy. Partly because of this transfer, other names for the concept of self-protection are currently used such as prevention or effort. Whatever the term adopted, self-protection activities reflect our attempt to reduce the probability of occurrence of "bad events" and these activities compete with other risk management tools such as market insurance, self-insurance, or diversification. With only one very recent exception (see below), all the economic models of self-protection are developed in a monoperiodic context (1) where the effort and its impact on the probability of a bad event are simultaneous. In a very recent paper, Menegatti (2009) has convincingly argued that while the monoperiodic model makes sense in many situations, it turns out that in other ones, a long time period may elapse between the effort and its impact on the probability of a bad event. (2) In such a context, effort becomes for the decision maker (DM) a risk management tool that competes with saving and long-term insurance. While much attention is paid to the impact of background risks in the literature devoted to insurance and saving, it is not the case for the self-protection problem. To the best of our knowledge, only Dachraoui et al. (2004) examine the impact of background risks on effort in a monoperiodic context. They conclude that the impact is ambiguous because both the marginal benefit and the marginal cost of efforts are increased by the background risk. While investments in effort are currently made to protect oneself against a specific risk that may materialize in the future, the DM also faces future risks that are beyond his control (the background risk). In this article, we analyze the impact of the presence and/or deterioration of such risks on the choice of the ex-ante level of effort. Because--as is well known--such future background risks also induce extra current savings ("precautionary savings") we use by analogy the terminology of "precautionary effort", that is, the additional effort level chosen to face the background risk. To achieve our goal, the article is organized as follows. In the next two sections, we first look at the impact of the introduction of a background risk on optimal effort and then consider the effect of a deterioration in a preexisting background risk. The section "An Extension" generalizes the previous analysis by extending the definition of the benefit of efforts along the lines developed in Jindapon and Neilson (2007). This section confirms the similarities between precautionary efforts and precautionary savings. A short conclusion summarizes the main results and indicates potential extensions. THE BASIC MODEL A DM avails upon an income [x.sub.o] that has to be allocated between current consumption and effort (e). Thanks to the effort, the DM faces in the next period a higher probability p(e) of a good outcome denoted x. With probability I - p(e), the DM receives the bad outcome x - l (l > 0) and his basic risk is thus represented by a binary random variable denoted [??]. Assuming that future utility is discounted at a rate [delta], the DM's optimization problem (3) is written: [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1) in which u and p(e) are increasing and concave functions. …

Precautionary Effort: A New Look

Abstract: While the concept of precautionary saving is well documented, that of precautionary effort has received relatively limited attention. In this note, we set up a two period model in order to analyze the conditions under which the introduction (or deterioration) of an independent background risk increases effort. INTRODUCTION Ehrlich and Becker's (1972) article initiated a very long research activity in economics around the notion of self-protection and its relationship with other risk management instruments. While many papers in economics still deal directly or indirectly on a regular basis with the topics, the discussion has spread over to other disciplines such as health management or environmental policy. Partly because of this transfer, other names for the concept of self-protection are currently used such as prevention or effort. Whatever the term adopted, self-protection activities reflect our attempt to reduce the probability of occurrence of "bad events" and these activities compete with other risk management tools such as market insurance, self-insurance, or diversification. With only one very recent exception (see below), all the economic models of self-protection are developed in a monoperiodic context (1) where the effort and its impact on the probability of a bad event are simultaneous. In a very recent paper, Menegatti (2009) has convincingly argued that while the monoperiodic model makes sense in many situations, it turns out that in other ones, a long time period may elapse between the effort and its impact on the probability of a bad event. (2) In such a context, effort becomes for the decision maker (DM) a risk management tool that competes with saving and long-term insurance. While much attention is paid to the impact of background risks in the literature devoted to insurance and saving, it is not the case for the self-protection problem. To the best of our knowledge, only Dachraoui et al. (2004) examine the impact of background risks on effort in a monoperiodic context. They conclude that the impact is ambiguous because both the marginal benefit and the marginal cost of efforts are increased by the background risk. While investments in effort are currently made to protect oneself against a specific risk that may materialize in the future, the DM also faces future risks that are beyond his control (the background risk). In this article, we analyze the impact of the presence and/or deterioration of such risks on the choice of the ex-ante level of effort. Because--as is well known--such future background risks also induce extra current savings ("precautionary savings") we use by analogy the terminology of "precautionary effort", that is, the additional effort level chosen to face the background risk. To achieve our goal, the article is organized as follows. In the next two sections, we first look at the impact of the introduction of a background risk on optimal effort and then consider the effect of a deterioration in a preexisting background risk. The section "An Extension" generalizes the previous analysis by extending the definition of the benefit of efforts along the lines developed in Jindapon and Neilson (2007). This section confirms the similarities between precautionary efforts and precautionary savings. A short conclusion summarizes the main results and indicates potential extensions. THE BASIC MODEL A DM avails upon an income [x.sub.o] that has to be allocated between current consumption and effort (e). Thanks to the effort, the DM faces in the next period a higher probability p(e) of a good outcome denoted x. With probability I - p(e), the DM receives the bad outcome x - l (l > 0) and his basic risk is thus represented by a binary random variable denoted [??]. Assuming that future utility is discounted at a rate [delta], the DM's optimization problem (3) is written: [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (1) in which u and p(e) are increasing and concave functions. …

Risk perceptions and management strategies by smallholder farmers in KwaZulu-Natal Province, South Africa

Abstract: Risk is a central issue in rural areas that affects many different aspects of people’s livelihoods in the developing world. Unless well managed, risks in agriculture can slow development and hinder poverty reduction. Farmers’ perceptions of and responses to risk are therefore important in understanding their risk behaviour. This paper examines risk perceptions and management strategies using field data collected from 200 smallholder rural farmers. The relationships between various socioeconomic characteristics and perceived sources of risk were also examined. In general, price, production and financial risks were perceived as the most important sources of risk. Using Principal Components Analysis, seven principal components (PCs) that explained 66.13% of the variation were extracted. Socio economic factors identified to have a significant relationship with the various sources of risk are age, gender, education, location, information access and risk-taking ability. The most important traditional risk management strategies used by the surveyed farmers were identified as crop diversification, precautionary savings and participating in social networks. The result of this study provides useful insights for policy makers, advisers, developers and sellers of risk management instruments.

Precautionary Savings in the Great Recession

Abstract: 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.

Precautionary Savings by Natives and Immigrants in Germany

Abstract: This paper analyses the savings behaviour of natives and immigrants in Germany. It is argued that uncertainty about future income and legal status (in case of immigrants) is a key component in the determination of the level of precautionary savings. Using the German Socio-economic Panel data it is shown that, although immigrants have lower levels of savings and are less likely to have regular savings than natives, the gap is significantly narrowed once we take loan repayments and remittances into account. Moreover, we find that marginal propensity to save for immigrants is about 40% higher than that for natives. We then exploit a natural experiment arising from a change in nationality law in Germany in 2000 to estimate the importance of precautionary savings. Using a difference-in-differences approach, we find that the easing of the requirements for naturalization has caused significant reductions of savings and remittances for immigrants as a whole, in the magnitude of 13% and 29% respectively, comparing to the pre-reform period. Our parametric specification shows that the introduction of the new nationality law reduces the gap between natives and immigrants in marginal propensity to save by 40% to 65%, depending on the measure of savings used. These findings suggest that much of the differences in terms of the savings behaviour between natives and immigrants are driven by the precautionary savings arising from the uncertainties about future income and legal status rather than cultural differences.

Households' savings in China

Abstract: The domestic saving rate in China is the highest in the world and it surpasses the investment share in GDP, which is also very high by international standards. This excessive saving results in a large current account surplus. Understanding why the Chinese save so much is a central issue in the debate on global imbalances. The goal of our paper is to analyse empirically Chinese household saving behaviour taking into account the disparities within the country, at the provincial level and between rural and urban households. We first show that, notwithstanding the rising contribution of government and firms to national savings the real peculiarity lies with Chinese families. We move from Modigliani and Cao's (2004) attempt to explain rising personal saving in China within the life cycle hypothesis and show how a more careful analysis indicates that life-cycle determinants do not suffice, especially in the most recent period. Once we consider regional differences and distinguish urban and rural households usin...

Income Risk, Saving and Taxation: Will Precautionary Saving Survive?

Abstract: Former theoretical and empirical studies find that precautionary savings are reduced in the presence of social security systems. The saving motive, however, does not change: individuals respond to increasing income risk by increasing their savings. Although this still holds for common tax and transfer systems, we show that this is not a feature of all tax and transfers systems. In contrast to former studies, we focus on the impact of the variability of future income (higher degree risk).

Wealth Inequality, Stock Market Participation, and the Equity Premium

Abstract: The last 30 years saw substantial increases in wealth inequality and in stock market participation, smaller increases in consumption inequality and the fraction of indebted households, a decline in interest rates and in the expected equity premium, as well as a prolonged stock market boom. Understanding the causes of these trends is crucial for many questions in finance and economics. In an incomplete markets, overlapping generations model we show that these trends can be jointly explained by the observed rise in wage inequality, as well as a decrease in participation costs and a loosening of borrowing constraints. Once we account for these changes, we show that the observed pattern of stock prices played a major role in increasing wealth inequality because stockholders, who tend to be wealthy, benefit most from a bull market. Crucially, these phenomena must be considered jointly; studying one independently leads to counterfactual predictions about others. For example, a loosening of credit standards is expected to raise, rather than lower interest rates through decreased precautionary savings as well as vastly increase the fraction of households in debt; an increase in labor inequality is (somewhat counterintuitively) expected to lower rather than raise wealth inequality, again through precautionary savings; increased stock market participation should also lower wealth inequality.

Structural Determinants of Household Savings in Turkey : 2003-2008

Abstract: Widening current account deficits coupled with low private saving rates in Turkey have started a recent policy debate on how household savings can be increased. Using Household Budget Surveys from 2003 to 2008, we study the structural determinants of household savings in Turkey. We consider various different definitions for savings, including durable consumption goods, education and health. Our findings are robust across different definitions. The results indicate that dependency ratios of households are important determinants of savings. Lower shares of dependent children or dependent elderly in the household imply higher saving rates. Moreover, female labor force participation has significant effects, i.e. households with higher shares of working females, have higher saving rates as well. We also find that households in which the head is self-employed or an employer have higher saving rates. Moreover, households with where pension payments constitute a larger share of income save less. Note that pension payments are always coupled with free health benefits. These findings point to strong evidence of precautionary savings.

Private Saving Rates and Macroeconomic Uncertainty: Evidence from Spanish Regional Data

Abstract: In this paper we address the recent evolution of saving rates in the Spanish economy using regional data. The onset of the Great Recession has been followed by increasing saving rates, which may reflect precautionary behaviour of households. Thus, we test precautionary saving theory for a panel of Spanish regions in the period 1980-2007, using two different tests for consumption growth and for saving rate. We estimate a panel data model with regional fixed effects and test for the effects on consumption of uncertainty about future income, proxied by income volatility and unemployment rate, together with other variables such as income growth rate, disposable income, inflation rate, wealth to income ratios, domestic private credit and socio-demographic factors. Our preliminary results suggest that part of the large increase in savings rates is related to a precautionary motive and that increased uncertainty causes greater savings rates. Our results also suggest that, in the case of the Spanish economy, the unemployment rate is a relevant variable to measure future income uncertainty.

Time-Varying Oil Price Volatility and Macroeconomic Aggregates

Abstract: 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.

Financial Development and Aggregate Saving Rates: A Hump-Shaped Relationship

Abstract: This study has documented a hump-shaped empirical relationship between financial development and the national saving rate across 12 East Asian and 31 OECD economies. An incomplete-market model featuring both heterogeneous households and heterogeneous firms is provided to explain this hump-shaped relationship. The key insight of the model is that financial development tends to reduce the precautionary-saving incentives of households but increase firms’ ability to borrow and invest. As a result, the aggregate saving rate may rise initially with financial development because of greater investment by fi rms, but then declines with further financial development because of substantially reduced precautionary savings by households. The model also predicts that the market interest rate lies substantially below the rate of return to capital in emerging economies, but the gap diminishes with fi nancial development, as observed in the data.

Prudence Demands Conservatism

Abstract: We define accounting information systems as conditionally conservative if they produce finer information at lower expected earnings levels. We then study the preference for differing levels of conditional conservatism among decision-maker(DM)'s with varying attributes including risk aversion and prudence. Similar to risk aversion, prudence is a metric based on DM's indirect utility that measures the sensitivity of DM's' decisions to changes in risk; prudent DM's save more as income becomes riskier. In a model of precautionary savings with information, we show that prudent DM's (those with positive prudence measures) prefer more conservative accounting systems, that imprudent DM's (those with negative prudence measures) prefer liberal accounting systems. We also show that conservative accounting may be preferred to a perfect information system if they are costly. We provide cases demonstrating the generality of our results, including examples where conservatism is preferred with increasing, constant and decreasing risk aversion.

Family dissolution and precautionary savings: an empirical analysis

Abstract: The main research question of this paper is whether or not the risk of family disruption has an impact on the consumption/saving decisions of households. Although little empirical work exists in this area, often presenting indirect evidence, the theory is divided over the effect of family risk over saving and wealth accumulation. By using data from the Italian Survey on Households Income and Wealth, we build a probabilistic model to assess the probability of marital splitting, and then we insert this probability as a distinct or interacted regressor, in a statistically consistent way, into a linear model of consumption. Furthermore, we study the differential behaviour, in terms of consumption/saving choices, of couples experiencing marital splitting over the subsequent 2 years. The main result of our analysis is that family disruption risk generates precautionary savings, reducing current consumption. In fact, according to our estimates, on average, the risk of divorce generates an amount of additional yearly precautionary savings of around 800 euros at constant prices of the year 2000, which represents 11% of overall household savings.

Optimal taxation with current and future cohorts

Abstract: This note demonstrates that optimal tax calculations in overlapping generations models should not be based exclusively on long-run welfare changes. As the latter represent a mix of efficiency and intergenerational redistribution effects, they typically favor policies which redistribute towards future cohorts. Taking the recent study of Conesa et al. (2009) as an example, we explicitly consider short- and long-run welfare effects and isolate the aggregate efficiency consequences of a tax reform. Based on this aggregate efficiency measure, we find a much lower capital income tax rate and a significantly less progressive labor income tax schedule than Conesa et al. (2009) to be optimal. As we demonstrate, the optimality of capital income taxation is explained by the low interest elasticity of precautionary savings compared to that of life-cycle savings.

The demand for mortgage debt, increases in house prices and the elderly home equity puzzle

Abstract: This paper studies the demand for mortgage debt in the Netherlands. Currently the size of this debt exceeds that of GDP, which makes is interesting to look at its determinants. We argue that the absence of a downpayment constraint is important and focus on two other issue. The first is the impact of the prolonged boom in house prices in the period 1985-2005, which makes it interesting to investigate how much of this increase in housing wealth has been ‘cashed’ by households. The second is the elderly home equity puzzle,’ or the habit of elderly people to leave their housing wealth untouched when aging. Recent analyses for the US have suggested that this behavior may be caused by the combination of a strong precautionary savings motive and a high risk of large health care costs. However, in the Netherlands long term care is publicly financed, which makes this explanation unlikely to be valid. It is therefore interesting to see if Dutch households liquefy substantial parts of their housing wealth by increasing the size of the mortgage loan.

Business Cycle Dependent Unemployment Bene…ts with Wealth Heterogeneity and Precautionary Savings

Abstract: In the wake of the …nancial and economic crisis the discussion about social insurance and optimal stabilization policies has re-blossomed. This paper adds to the literature by studying the eects of a business cycle dependent level of unemployment bene…ts in a model with labor market matching, wealth heterogeneity, precautionary savings, and aggregate ‡uctuations in productivity. The results are ambiguous: both procyclical and countercyclical unemployment bene…ts can increase welfare relative to business cy- cle invariant bene…ts. Procyclical bene…ts are bene…cial due to countercyclicality of the distortionary eect (on job creation) from providing unemployment insurance, whereas countercyclical bene…ts facilitate consumption smoothing.

Terms of Trade Uncertainty and Business Cycle Fluctuations

Abstract: The recent commodity price boom and the financial crisis have been accompanied by a large increase in price volatility, resulting in a significant increase in the uncertainty associated with the terms of trade for many countries. I study the eects of terms of trade uncertainty on Chilean business cycles through the lens of a small open economy DSGE model. Sequential Monte Carlo Methods are used to estimate a stochastic volatility model to deal with the latent state “uncertainty”. The findings are fourfold. First, there is considerable evidence for time-varying terms of trade uncertainty in the data. Second, the ex-ante and ex-post eects of increased terms of trade uncertainty can account for about one fifth of Chilean output fluctuations at business cycle frequencies. Third, a two-standard deviation terms of trade risk shock, i.e. a 54 percent increase in uncertainty, leads to a 0.1 percent drop in output. The fact that terms of trade uncertainty more than doubled during the recent commodities boom suggests that the contribution of terms of trade risk during this more recent period may have been substantial. Finally, I show that both the precautionary savings motive of the representative household and the expansionary response of the central bank mitigate the drop in GDP.

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

Abstract: 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.