Optimal Consumption and Savings Decisions with Disastrous Income Risk: Revisiting Rietz's Rare Disaster Risk Hypothesis

45 Pages Posted: 4 May 2023

See all articles by Chusu He

Chusu He

University of Bath - School of Management

Alistair Milne

Loughborough University - School of Business and Economics

Seyoung Park

Nottingham University Business School

Multiple version iconThere are 2 versions of this paper

Date Written: May 3, 2023

Abstract

In this paper, we develop an analytically tractable dynamic model of optimal consumption and savings decisions with disastrous income risk. We first empirically explore the relations among consumption changes, aggregate income, disaster shock severity, and fiscal measures in 55 countries during the Covid-19 period. We then by empirical motivation investigate an important role of insurance with a focus on the recovery of income in a disaster. We highlight how extent of the disastrous income risk to which the agent is exposed and her income recovery post disaster jointly affect the agent's optimal decisions. Overall, availability of insurance can be particularly important for both the poor and the wealthy in the sense that they could even consume more, save less, and invest more post disaster as long as their future income is (partly) recovered.

Keywords: Optimal Consumption, Optimal Savings, Disastrous Income Risk, Insurance

JEL Classification: D15, D58, G11, G12

Suggested Citation

He, Chusu and Milne, Alistair K. L. and Park, Seyoung, Optimal Consumption and Savings Decisions with Disastrous Income Risk: Revisiting Rietz's Rare Disaster Risk Hypothesis (May 3, 2023). Available at SSRN: https://ssrn.com/abstract=4437511 or http://dx.doi.org/10.2139/ssrn.4437511

Chusu He

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Alistair K. L. Milne

Loughborough University - School of Business and Economics ( email )

Epinal Way
Loughborough
Leicestershire, LE11 3TU
United Kingdom

Seyoung Park (Contact Author)

Nottingham University Business School ( email )

Nottingham University Business School
Jubilee Campus
Nottingham
United Kingdom
+44-7927-494518 (Phone)

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