This paper examines the effects of households’ shocks on saving behaviour. It investigates the possibility that households save ex ante to buffer against adverse weather and health shocks. The relatively high prevalence rate of HIV/AIDS in Kenya combined with rain fed agriculture implies great uncertainty for rural livelihoods. Adopting a methodology previously used on cross-sectional data (Paxson, 1992), the paper examines the level of households precautionary behaviour. This is done by estimating the marginal propensity to save out of transitory income over a period of 18 months. The results show that while households may exhibit some level of prudence, the marginal propensity to save out of transitory income is about a third of what the permanent income hypothesis postulates. Seasonality influences prudence behaviour, with stressful seasons likely to depress substantially the level of precautionary saving. The presence of HIV/AIDS illness lowers savings and raises per capita consumption. While reduced savings may seem to jeopardize future investments, the rise in consumption when the human asset is threatened, is in accordance with behaviour of forward-looking agents when future income is endogenous to current asset shock. The desire to smooth the health (asset) stock outweighs the desire (ability) to smooth future consumption and therefore savings decline. As a consequence, consumption for the HIV-afflicted households is relatively more volatile. While these findings are in agreement with a buffer stock model, they go against previous predictions that, AIDS medical costs will be met by reducing both consumption and savings in a balanced manner, and not necessarily be drawn disproportionately from own savings. A rise in consumption and a drop in savings may be a signal that the relationship is likely to be disproportionate
