Precautionary Motives with Multiple Instruments
45 Pages Posted: 22 Jul 2021 Last revised: 7 Sep 2021
Date Written: July 20, 2021
Using a unified approach, we show how precautionary saving, self-protection and self-insurance are jointly determined by risk preferences and the preference over the timing of uncertainty resolution. We cover higher-order risk effects and examine both risk averters and risk lovers. When decision-makers use several instruments simultaneously to respond to income risk, substitutive interaction effects arise. We quantify precautionary and substitution effects numerically and discuss the role of instrument interaction for the inference of preference parameters from precautionary motives. Instruments can differ substantially in the size of the precautionary motive and in the susceptibility to substitution effects. This affects their suitability for the identification of precautionary preferences.
Keywords: Recursive preferences, prudence, precautionary behavior, interaction effects, comparative statics
JEL Classification: D11, D80, D81, G22
Suggested Citation: Suggested Citation