Concave consumption function and precautionary wealth accumulation

Abstract

This paper examines the theoretical foundations of precautionary wealth accumulation in a multi-period model where consumers face uninsurable earnings risk and borrowing constraints. We begin by characterizing the consumption function of individual consumers. We show that consumption function is concave when the utility function has strictly positive third derivative and the inverse of absolute prudence is a concave function. These conditions encompass all HARA utility functions with strictly positive third derivative as special cases. We then show that when consumption function is concave, a mean-preserving spread in earnings risk would encourage wealth accumulation at both the individual and aggregate levels.Consumption function, borrowing constraints, precautionary saving