Essays on stochastic intertemporal household choice.

Abstract

This dissertation consists of three self-contained chapters on households' intertemporal choice under uncertainty. In the first chapter, I explore a model that extends the standard buffer-stock saving problem to accommodate flexible labor supply and consumer durables, including housing. These two factors significantly alter households' intertemporal decision-making under collateral constraints requiring a minimum downpayment. Using numerical solutions, I first show that households will hold considerably less liquid assets as precautionary saving. This is because the labor supply flexibility or consumer durables acts as a buffer that can be a substitute for liquid assets. I also find that the presence of durables and their downpayment requirement can generate labor supply that is more responsive to permanent changes in the real wage. In addition, using a life-cycle framework, I present that with a lower required downpayment rate, on average net wealth decreases, but both gross financial assets and the stock of durables increase. Finally, I reveal that the retirement income replacement ratio has little effect on the behavior of the young, while it has a significant effect on the behavior of those approaching retirement. In the second chapter, I show that the persistence of income shocks is an important factor in determining the size of precautionary saving and precautionary portfolio choice effects. Greater persistence of income shocks causes people to do more precautionary saving and invest less in risky assets. Perturbation methods are used in order to yield approximate analytical expressions for precautionary saving and precautionary portfolio choice. In the third chapter, I present an analysis of the effects of liquidity constraints on the consumption function in a continuous-time, perfect-foresight model of an impatient consumer. This analysis is viewed as an investigation of the foundations of the buffer-stock model, which adds uncertainty to the model analyzed. I show that liquidity constraints have a significant effect on consumption and its time path, even long before the constraint binds. I also find that the marginal propensity to consume wealth becomes effectively infinite at very low levels of wealth. At these low wealth levels, a liquidity-constrained, impatient consumer will plan to spend the remaining wealth very fast.