Adaptive Consumption Behavior
69 Pages Posted: 21 Oct 2009 Last revised: 28 Aug 2010
Date Written: October 2009
This paper proposes and studies a theory of adaptive consumption behavior under income uncertainty and liquidity constraints. We assume that consumption is governed by a linear function of wealth, whose coefficients are revised each period by a procedure, which, although sophisticated, places few informational or computational demands on the consumer. We show that under a variety of settings, our procedure converges quickly to a set of coefficients with low welfare cost relative to a fully optimal nonlinear consumption function.
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