Saving for a Sunny Day

The paper presented in this Mannheim Applied Seminar document using PSID data that consumption is both more variable and more prone to large, episodic bursts among wealthier individuals. This behavior is inconsistent with widely used frameworks for consumption and savings. To close this gap, the authors embed randomly valued, discretionary expenditures in an otherwise standard consumption-savings problem. They show that in addition to matching the empirical profile of consumption variability over wealth, this structure also gives rise to a novel precautionary savings motive that is particularly salient among the wealthy. This force amplifies the concentration of wealth in equilibrium in the right tail without appealing to, for example, heterogeneous discount factors, stochastic returns, or bequest motives, closing the gap relative to the data for a standard incomplete markets model by as much as 50%.