Emergency Fund Levels: Is Household Behavior Rational?

Abstract

Empirical studies have found that most households do not have recommended levels of emergency funds. A three-period model of optimal consumption is presented. The theoretical model suggests that many consumers without recommended levels of liquid assets may be acting rationally. The model is tested empirically with the 1983-1986 panels of the Surveys of Consumer Finances. Empirical findings support the model in that households who could have expected to have decreases in future real income were significantly more likely to hold adequate emergency fund reserves than those who could have expected to have no decline in real income.

JEL Classification: D91, E21