First-order prudence and its implications for precautionary savings and the risk-free rate
Prudence is widely known for inducing precautionary saving behavior. This paper revisits this important implication by introducing the notions of first-order and second-order prudence. Within smooth expected utility (EU), prudence is second-order. In that case, the presence of a small, positive-mean...
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| Main Authors: | , |
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| Format: | Article (Journal) Book/Monograph |
| Language: | English |
| Published: |
Rochester, NY
Elsevier
January 27, 2023
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| DOI: | 10.2139/ssrn.4339507 |
| Online Access: | Verlag, kostenfrei, Volltext: https://doi.org/10.2139/ssrn.4339507 Verlag, lizenzpflichtig, Volltext: https://papers.ssrn.com/abstract=4339507 Verlag, kostenfrei: https://ssrn.com/abstract=4339507 
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| Author Notes: | Sebastian Ebert, Paul Karehnke |
| Summary: | Prudence is widely known for inducing precautionary saving behavior. This paper revisits this important implication by introducing the notions of first-order and second-order prudence. Within smooth expected utility (EU), prudence is second-order. In that case, the presence of a small, positive-mean risk to future wealth reduces saving, while first-order prudence can increase them. The latter is the case for non-EU theories such as rank-dependent or reference-dependent utility, and the increased savings help resolve the so-called risk-free rate puzzle. By proposing a novel utility function that features first-order prudence, we show that the risk-free rate puzzle can be resolved even within the EU paradigm. |
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| Item Description: | Gesehen am 20.03.2023 |
| Physical Description: | Online Resource |
| DOI: | 10.2139/ssrn.4339507 |
| Access: | Open Access |