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Consumption and saving behaviour under uncertainty with unorthodox preferences.

Perez-Kakabadse, H. Alonso (2010) Consumption and saving behaviour under uncertainty with unorthodox preferences. PhD thesis, London School of Economics and Political Science (United Kingdom).

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Abstract

This thesis consists of three theoretical essays on the consumption and saving behavior of agents with unorthodox preference specifications in an uncertain environment. The first paper puts forward a model in which agents have heterogeneous priors with regard to their assessment of the underlying systemic risk. It considers the particular case of domestic agents being more pessimistic than financial markets. The second paper studies the effects of dynamic inconsistency in the consumption and saving decisions under systemic risk, assuming naive hyperbolic agents. The third paper investigates the joint consumption-savings and portfolio-selection problem under capital risk, assuming sophisticated hyperbolic discounting agents. Chapter 1 introduces an economy exposed to external stochastic shocks capable of triggering a crisis. We show that under the assumption of heterogeneity of beliefs, and in particular of pessimistic domestic consumers, it is possible to explain demand booms that arise on the back of policy responses even when the latter were not wealth improving. Quite the opposite, such an expenditure boom could be sparked in conjunction with a cycle of persistent current account deficits and debt accumulating dynamics that would result in higher future risk of collapse. Chapter 2 considers a setting in which time inconsistent agents discount utility flows with a hyperbolic function instead of a classic, exponential one. This feature effectively characterizes a consumer that is "present biased" or short-term impatient. The agent is assumed to be naive, in the sense that she does not internalize her time inconsistency problem. As opposed to the orthodox, exponential discounting model, our model is able to generate a negative relationship between the saving rate (or the current account) and the underlying risk premium. Chapter 3 solves the classic Merton (1969, 1971) problem of optimal consumption- saving and portfolio-selection in continuous time, assuming sophisticated but time-inconsistent agents with hyperbolic preferences as specified in Harris and Laibson (2008). We find closed-form solutions for the optimal consumption and portfolio allocation rules. The portfolio rule remains identical to the time-consistent solution with power utility with no borrowing constraints. However, the marginal propensity to consume out of wealth is unambiguously greater than the time-consistent, exponential case.

Item Type: Thesis (PhD)
Uncontrolled Keywords: Economics, General
Sets: Collections > ProQuest Etheses
Departments > Economics
URI: http://etheses.lse.ac.uk/id/eprint/2789

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