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The effects of uncertainty on optimal consumption

Mason, R. and Wright, S. (1999) The effects of uncertainty on optimal consumption , Southampton, UK Economics Division, School of Social Sciences, University of Southampton 34pp. (Discussion Papers in Economics and Econometrics, 9907).

Record type: Monograph (Discussion Paper)


When marginal utility is convex and there is pure labour income uncertainty, certain results are well-known. Asset return uncertainty is often assumed to have qualitatively similar effects; see e.g. Skinner (1988). We show that this assumption is not correct. Asset return uncertainty gives rise to an additional term in the Euler equation, which by introducing a role for current cash-in-hand, may work in the opposite direction to the precautionary motive, leading to ambiguity in the slope of the expected consumption time profile. We present a linearised version of the Euler equation, and an associated closed form solution, in order to provide intuition for these results. Numerical analysis indicates that the approximation is reasonable for empirically plausible estimates of the variances of the underlying disturbances.

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Published date: 30 June 1999


Local EPrints ID: 33142
PURE UUID: 9bafe2b2-1b1f-42f7-8ef5-6183a5c947da

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Date deposited: 10 May 2007
Last modified: 17 Jul 2017 15:53

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Author: R. Mason
Author: S. Wright

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