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Euler Equations, Subjective Expectations and Income Shocks

Attanasio, O; Kovacs, A; Molnar, K; (2020) Euler Equations, Subjective Expectations and Income Shocks. Economica , 87 (346) pp. 406-441. 10.1111/ecca.12318. Green open access

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Abstract

In this paper, we make three substantive contributions. First, we use elicited subjective income expectations to identify the levels of permanent and transitory income shocks in a lifecycle framework. Second, we use these shocks to assess whether households’ consumption is insulated from them. Third, we use the shock data to estimate an Euler equation for consumption. We find that households are able to smooth transitory shocks, but adjust their consumption in response to permanent shocks, albeit not fully. The estimates of the Euler equation parameters with and without expectational errors are similar, which is consistent with rational expectations. We break new ground by combining data on subjective expectations about future income from the Michigan Survey with microdata on actual income from the Consumer Expenditure Survey.

Type: Article
Title: Euler Equations, Subjective Expectations and Income Shocks
Open access status: An open access version is available from UCL Discovery
DOI: 10.1111/ecca.12318
Publisher version: https://doi.org/10.1111/ecca.12318
Language: English
Additional information: This version is the author accepted manuscript. For information on re-use, please refer to the publisher’s terms and conditions.
Keywords: life cycle models; estimating Euler Equations; survey expectations
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of S&HS > Dept of Economics
URI: https://discovery.ucl.ac.uk/id/eprint/10079904
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