Consumption Commitments and Risk Preferences

53 Pages Posted: 21 Aug 2006 Last revised: 27 Jul 2022

See all articles by Raj Chetty

Raj Chetty

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Adam Szeidl

Central European University

Date Written: August 2006

Abstract

Many households devote a large fraction of their budgets to "consumption commitments" -- goods that involve transaction costs and are infrequently adjusted. This paper characterizes risk preferences in an expected utility model with commitments. We show that commitments affect risk preferences in two ways: (1) they amplify risk aversion with respect to moderate-stake shocks and (2) they create a motive to take large-payoff gambles. The model thus helps resolve two basic puzzles in expected utility theory: the discrepancy between moderate-stake and large-stake risk aversion and lottery playing by insurance buyers. We discuss applications of the model such as the optimal design of social insurance and tax policies, added worker effects in labor supply, and portfolio choice. Using event studies of unemployment shocks, we document evidence consistent with the consumption adjustment patterns implied by the model.

Suggested Citation

Chetty, Nadarajan (Raj) and Szeidl, Adam, Consumption Commitments and Risk Preferences (August 2006). NBER Working Paper No. w12467, Available at SSRN: https://ssrn.com/abstract=924753

Nadarajan (Raj) Chetty (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-0708 (Phone)
510-643-0413 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Adam Szeidl

Central European University ( email )

Nador u. 9.
Budapest H-1051
Hungary
+36 1 327 3000 (Phone)
+36 1 327 3232 (Fax)