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Optimistic about the future? How uncertainty and expectations about future consumption prospects affect optimal consumer behavior

Author

Listed:
  • Kakeu Johnson

    (Morehouse College, Department of Economics, 830 Westview Drive, S.W, Atlanta, Georgia 30314, USA)

  • Byron Sharri

    (Drew University, 36 Madison Avenue, Madison, New Jersey 07940, USA)

Abstract

This paper analyzes a continuous time stochastic growth model with a Duffie and Epstein (Duffie, D., and L. Epstein. 1992. “Stochastic Differential Utility.” Econometrica 60: 353–394.) recursive utility. We find that optimal consumption decisions are determined in a non trivial way by factors such as changes in expectations about future prospects (sentiment), and a matrix of weights that expresses the sensitivity of the consumer to a global macroeconomic risk. The weighting matrix can also be thought of as a measure of multivariate prudence.The sentiment channel is governed by two forces working in opposite directions; one is related to the consumer’s aversion to long-run risk and the other is related to the consumer’s aversion to short-run risk. The greater is the aversion to long-run risk relative to the aversion to short-run risk, the higher is the magnitude of the sentiment effect. This suggests a linkage between the sentiment effect and temporal risk attitudes.

Suggested Citation

  • Kakeu Johnson & Byron Sharri, 2016. "Optimistic about the future? How uncertainty and expectations about future consumption prospects affect optimal consumer behavior," The B.E. Journal of Macroeconomics, De Gruyter, vol. 16(1), pages 171-192, January.
    • Handle: RePEc:bpj:bejmac:v:16:y:2016:i:1:p:171-192:n:5
    DOI: 10.1515/bejm-2014-0155
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    References listed on IDEAS

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    1. Fernando Restoy & Philippe Weil, 2011. "Approximate Equilibrium Asset Prices," Review of Finance, European Finance Association, vol. 15(1), pages 1-28.
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    3. David Crainich & Louis Eeckhoudt & Olivier Le Courtois, 2013. "An index of (absolute) correlation aversion: theory and some implications," Working Papers 2013-ECO-12, IESEG School of Management.
    4. Anne Epaulard & Aude Pommeret, 2003. "Recursive Utility, Endogenous Growth, and the Welfare Cost of Volatility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 672-684, July.
    5. repec:hal:wpspec:info:hdl:2441/5l6uh8ogmqildh09h4838ip3n is not listed on IDEAS
    6. Max Gillman & Michal Kejak & Michal Pakoš, 2015. "Learning about Rare Disasters: Implications For Consumption and Asset Prices," Review of Finance, European Finance Association, vol. 19(3), pages 1053-1104.
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    8. Han Hong, 2007. "A Statistical Inquiry into the Plausibility of Recursive Utility," Journal of Financial Econometrics, Oxford University Press, vol. 5(4), pages 523-559, Fall.
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    Cited by:

    1. Maria Vincenza Ciasullo & Gennaro Maione & Carlo Torre & Orlando Troisi, 2017. "What about Sustainability? An Empirical Analysis of Consumers’ Purchasing Behavior in Fashion Context," Sustainability, MDPI, vol. 9(9), pages 1-18, September.

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    More about this item

    Keywords

    aversion to long-run risk; aversion to short-run risk; continuous-time stochastic recursive utility; endogenous growth model; sentiment about the future; sentiment effect;
    All these keywords.

    JEL classification:

    • D9 - Microeconomics - - Micro-Based Behavioral Economics
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment

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