Determinants of Precautionary Savings: Elasticity of Intertemporal Substitution vs. Risk Aversion

Determinants of Precautionary Savings: Elasticity of Intertemporal Substitution vs. Risk Aversion

Title : Determinants of Precautionary Savings: Elasticity of Intertemporal Substitution vs. Risk Aversion
Number : 12/27
Author(s) : Arif Oduncu
Language : English
Date : August 2012
Abstract : The purpose of this paper is to understand the effects of the elasticity of intertemporal substitution (EIS) and risk aversion on savings separately and determine which coefficient is more important factor for precautionary savings. This is an important question since a significant fraction of the capital accumulation is due to precautionary savings according to literature. Thus, knowing the important determinant of precautionary savings will be helpful to understand the capital accumulation mechanism. This paper uses an Epstein-Zin utility function, which permits risk attitudes to be disentangled from the degree of intertemporal substitutability, in the model in order to study the effects of EIS and risk aversion separately. It is shown that saving increases as EIS increases. Similarly, saving increases as the coefficient of risk aversion increases. More importantly, it is observed that EIS is a more important factor for precautionary savings than risk aversion because saving is more responsive to changes in EIS than changes in risk aversion.
Keywords : Precautionary Savings, Epstein-Zin Utility Function, Coefficient of Risk Aversion, Elasticity of Intertemporal Substitution
JEL Codes : C61; C63; E21; E27

Determinants of Precautionary Savings: Elasticity of Intertemporal Substitution vs. Risk Aversion
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