A Theory of Saving under Risk Preference Dynamics

TL;DR

This paper develops a comprehensive theory of optimal savings considering dynamic risk preferences, explaining why wealthy households exhibit high savings and low MPCs, aligning better with empirical observations.

Contribution

It introduces a model allowing risk aversion to vary over time and states, showing that zero MPCs can naturally emerge under realistic conditions.

Findings

Zero asymptotic MPCs occur with positive probability of reduced risk aversion.

Heterogeneity in risk attitudes significantly alters savings dynamics.

The model aligns with empirical patterns of wealthy household savings behavior.

Abstract

Empirical evidence shows that wealthy households have substantially higher saving rates and markedly lower marginal propensity to consume (MPC) than other groups. Existing theory cannot account for this pattern unless under restrictive assumptions on returns, discounting, and preferences. This paper develops a general theory of optimal savings with preference shocks, allowing risk aversion to vary across states and over time, and shows that incorporating such heterogeneity in risk attitudes fundamentally reshapes the asymptotic dynamics of consumption and saving. In particular, zero asymptotic MPCs (100% asymptotic saving rates) arise under markedly weaker conditions than in existing theory. Strikingly, such outcomes occur whenever there is a positive probability that agents become less risk averse in the future. Therefore, the vanishing MPC emerges as a generic feature rather than a knife-edge result of the optimal savings model, offering a more theoretically robust and empirically consistent account of the saving behavior of wealthy households.