Savings Functions
Taking care

Several authors have established theoretically that precautionary saving increases with the variance and persistence of income shocks and declines as individual wealth rises, but there is virtually no empirical evidence on its extent, since the subjective uncertainty of future income fluctuations is unobservable. In Discussion Paper No. 699, Luigi Guiso, Research Affiliate Tullio Jappelli and Daniele Terlizzese test for precautionary saving using direct survey information on households' subjective assessments of earnings uncertainty drawn from Italy's 1989 Survey of Household Income and Wealth. In their model, households maximize utility over an infinite horizon and after-tax wage income depends on its own previous value, a deterministic component and a random shock. Consumption comprises the certainty-equivalence level and a component identified with precautionary saving. The relevant measure of uncertainty is human-wealth uncertainty, which depends in turn on the variance and persistence of income shocks.

The authors estimate three specifications of the consumption function to show that subjective earnings uncertainty increases saving and precautionary saving declines with individual wealth. At sample means, this accounts for 2% of households' net worth, so households typically hold some $3,000 to protect themselves from adverse income shocks. This seems very little, and the results suggest that earnings uncertainty cannot explain a large fraction of asset accumulation. But this apparently low level of income-related precautionary saving may reflect informal risk- sharing arrangements among households. Survey respondents in Italy and elsewhere consistently cite emergencies as a main reason for saving, and future empirical studies may reveal that other risks related to health and mortality are also important determinants of saving.

Earnings Uncertainty and Precautionary Saving
Luigi Guiso, Tullio Jappelli and Daniele Terlizzese

Discussion Paper No. 699, June 1992 (IM)