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American Economic Journal: Macroeconomics: Vol. 2 No. 4 (October 2010)

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Risk-Sensitive Consumption and Savings under Rational Inattention

Article Citation

Luo, Yulei, and Eric R. Young. 2010. "Risk-Sensitive Consumption and Savings under Rational Inattention." American Economic Journal: Macroeconomics, 2(4): 281-325.

DOI: 10.1257/mac.2.4.281

Abstract

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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Authors

Luo, Yulei (U Hong Kong)
Young, Eric R. (U VA)

JEL Classifications

D11: Consumer Economics: Theory
D81: Criteria for Decision-Making under Risk and Uncertainty
D82: Asymmetric and Private Information
E13: General Aggregative Models: Neoclassical
E21: Macroeconomics: Consumption; Saving; Wealth

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American Economic Journal: Macroeconomics


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