The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives

John H. Cochrane

210 citations0/0 files storedNational Bureau of Economic Research

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Monetary Policy and Economic Impact Financial Literacy, Pension, Retirement Analysis Economic theories and models

Abstract

This paper presents calculations of the utility cost to consumers of following alternative decision rules in the environments specified by tests of the intertemporal allocation of consumption on aggregate data.The alternatives include excess and inadequate sensitivity to income and interest rate changes and ignoring information.The calculations find that the costs of large deviations from the optimal decision rule--consumption equal to current income, for example--are on the order oflc to $1 per quarter.They are interpreted to suggest that the theory does not make predictions that are robust to small inaccuracies of modelling, including small costs of transactions and information, and that those small costs can account for rejections of the theory as it is applied to aggregate US data.

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References

1978Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence 1987Mean Reversion in Stock Prices: Evidence and Implications 1988RATIONALITY AS PROCESS AND AS PRODUCT OF THOUGHT 1983Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns 1987Models of business cycles 1981The Adjustment of Consumption to Changing Expectations About Future Income 1985A Near-Rational Model of the Business Cycle, with Wage and Price Inertia 1988Models of Business Cycles.

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