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Optimal irrational behavior in continuous time

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  • Feigenbaum, James
  • Caliendo, Frank N.

Abstract

Feigenbaum et al. (2009) showed in a two-period overlapping generations model that households can improve upon the rational, competitive equilibrium while maintaining competitive factor markets if agents coordinate upon an irrational consumption/saving rule. We generalize their findings to continuous time. The optimal consumption rule with coordination implies a U-shaped lifecycle consumption profile. Rational agents living in a standard competitive equilibrium would need a 4% increase of consumption in every period across the lifecycle to reach the level of utility that can be achieved under coordination. Most of this gain can be achieved with a linear saving rule.

Suggested Citation

  • Feigenbaum, James & Caliendo, Frank N., 2010. "Optimal irrational behavior in continuous time," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1907-1922, October.
    • Handle: RePEc:eee:dyncon:v:34:y:2010:i:10:p:1907-1922
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    References listed on IDEAS

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    1. Richard H. Thaler & Shlomo Benartzi, 2004. "Save More Tomorrow (TM): Using Behavioral Economics to Increase Employee Saving," Journal of Political Economy, University of Chicago Press, vol. 112(S1), pages 164-187, February.
    2. Gary Hansen & Selahattin Imrohoroglu, 2008. "Consumption over the Life Cycle: The Role of Annuities," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 566-583, July.
    3. Bullard, James & Feigenbaum, James, 2007. "A leisurely reading of the life-cycle consumption data," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2305-2320, November.
    4. Feigenbaum, James & Gahramanov, Emin & Tang, Xueli, 2013. "Is it really good to annuitize?," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 116-140.
    5. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January.
    6. Thurow, Lester C, 1969. "The Optimum Lifetime Distribution of Consumption Expenditures," American Economic Review, American Economic Association, vol. 59(3), pages 324-330, June.
    7. Feigenbaum, James & Caliendo, Frank N. & Gahramanov, Emin, 2011. "Optimal irrational behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 77(3), pages 285-303, March.
    8. Heckman, James J, 1974. "Life Cycle Consumption and Labor Supply: An Explanation of the Relationship Between Income and Consumption Over the Life Cycle," American Economic Review, American Economic Association, vol. 64(1), pages 188-194, March.
    9. James Feigenbaum, 2006. "Precautionary Saving Unfettered," Working Paper 227, Department of Economics, University of Pittsburgh, revised Jan 2006.
    10. Findley, T. Scott & Caliendo, Frank N., 2010. "Does it pay to be SMarT?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 9(3), pages 321-344, July.
    11. Feigenbaum, James, 2008. "Can mortality risk explain the consumption hump?," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 844-872, September.
    12. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
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    Cited by:

    1. Feigenbaum, James & Gahramanov, Emin & Tang, Xueli, 2013. "Is it really good to annuitize?," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 116-140.
    2. Feigenbaum, James & Caliendo, Frank N. & Gahramanov, Emin, 2011. "Optimal irrational behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 77(3), pages 285-303, March.

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