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Overconfidence and Consumption over the Life Cycle

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Author Info
Frank Caliendo () (Department of Economics, Colorado State University)
Kevin X.D. Huang () (Department of Economics, Vanderbilt University)
Abstract

Overconfidence is a widely documented phenomenon. In this paper, we study the implications of consumer overconfidence in a life-cycle consumption/saving model. Our main analytical result is a necessary and sufficient condition under which any degree of overconfidence concerning the mean return on savings can produce a hump in the work-life consumption profile. This condition is almost always met in the data. We show by simulations that overconfidence concerning the variance of the return can have little effect on the long-run average behavior of consumption over the life cycle, and that our basic conclusion is fairly robust with various realistic modifications to the baseline model. We interpret the general applicability of our analytical framework and discuss our numerical results in the light of aggregate consumption data.

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File URL: http://www.vanderbilt.edu/Econ/wparchive/workpaper/vu07-w12.pdf
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Paper provided by Department of Economics, Vanderbilt University in its series Working Papers with number 0712.

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Date of creation: Aug 2007
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Handle: RePEc:van:wpaper:0712

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Related research
Keywords: Overconfidence; consumption; life cycle; time inconsistency; hump shape;
> elasticity of intertemporal substitution

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Find related papers by JEL classification:
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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