Rules of Thumb in Household Savings Decisions: Estimation Using Threshold Regression

47 Pages Posted: 6 Nov 2019

See all articles by Jorge Sabat

Jorge Sabat

Universidad Diego Portales

Emily Gallagher

University of Colorado at Boulder - Department of Finance; Federal Reserve Banks - Federal Reserve Bank of St. Louis

Date Written: September 17, 2019

Abstract

The rules of thumb offered by financial advisors regarding how much to hold in liquid reserves vary widely and usually imply far greater sums than low-income households save. This paper seeks empirically-grounded insights into the minimum liquidity buffer needed by the average low-income household. First, we document diminishing benefits to liquid savings in terms of the likelihood of experiencing financial hardship. Then, we formalize this relationship with a theory of poverty traps. Finally, to observed data, we fit a regression kink model with an unknown threshold (kink) point that must be estimated. Our key finding is that the threshold point is $2,467 with a 95% confidence interval of $1,814–$3,011 (in 2019 dollars) or roughly 1 month of income for the average low-income household – which is far less than the savings amounts implied by common rules of thumb (typically 3–6 months of income). Theoretical evidence suggests that financial advice based on an empirically-estimated threshold point is welfare enhancing for households with naive perceptions of their probability of experiencing financial problems.

Keywords: household finance, threshold regressions, financial advice, savings, debt puzzle

JEL Classification: D14, D11

Suggested Citation

Sabat, Jorge and Gallagher, Emily, Rules of Thumb in Household Savings Decisions: Estimation Using Threshold Regression (September 17, 2019). Available at SSRN: https://ssrn.com/abstract=3455696 or http://dx.doi.org/10.2139/ssrn.3455696

Jorge Sabat

Universidad Diego Portales ( email )

Av. Santa Clara 797
Santiago, Región Metropolitana
Chile

HOME PAGE: http://https://sites.google.com/site/jorgesabat/home

Emily Gallagher (Contact Author)

University of Colorado at Boulder - Department of Finance ( email )

Campus Box 419
Boulder, CO 80309
United States

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

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