Lorenzo Pozzi

Income Uncertainty and Aggregate Consumption

We investigate the relevance of aggregate and consumer-specific income uncertainty for aggregate consumption changes in the US over the period 1952-2001. Theoretically, the effect of income risk on consumption changes is decomposed into an aggregate and into a consumer-specific part. Empirically, aggregate risk is modelled through a GARCH process on aggregate income shocks and individual risk is modelled as an unobserved component and obtained through Kalman filtering. Our results suggest that aggregate income risk explains a negligible fraction of the variance of aggregate consumption changes. A more important part of aggregate consumption changes is explained by the unobserved component. The interpretation of this component as reflecting consumer-specific income risk is supported by the finding that it is negatively affected by received consumer transfers.

The coefficient of relative risk aversion: a Monte Carlo study investigating small sample estimator problems

Abstract When estimating consumer Euler equations using the Generalized Method of Moments, negative estimates for the coefficient of relative risk aversion are frequently found. In this paper we suggest that this anomaly may be due to a small sample bias. Based on Monte Carlo simulations we show that the estimate of the coefficient of relative risk aversion tends to have a negative bias. Our results suggest that the other estimates in the equation are not (as seriously) biased. Inference is problematic, however, since the standard errors of the estimates tend to be underestimated. We illustrate these points through the estimation of an Euler equation using annual data for Belgium.

Have Euro Area Government Bond Risk Premia Converged To Their Common State

We derive a model in which a standard international capital asset pricing (ICAPM) model is nested within an ICAPM model with market imperfections. In the latter model an idiosyncratic stochastic factor affects the return of risky assets (over a risk-free rate) on top of the systematic component that is common to all countries (and that is interacted with a timevarying idiosyncratic “beta”). We introduce asymptotic convergence from the full ICAPM model with imperfections to the standard model by multiplying the idiosyncratic factor by convergence operators. The model is then estimated using the weekly 10 year government bond spreads of Belgium, France, Italy, and the Netherlands versus Germany over the period 1991-2006. We find that the idiosyncratic components have converged towards zero for all countries after the introduction of the euro implying that the efficiency of the euro area government bond markets under consideration has increased. Full convergence has not yet occurred however.

Business Cycle Fluctuations and Excess Sensitivity of Private Consumption

We investigate whether business cycle fluctuations affect the degree of excess sensitivity of private consumption growth to disposable income growth. Using multivariate state space methods and quarterly US data for the period 1965–2000, we find that excess sensitivity is significantly higher during recessions.

Business Cycle Fluctuations and Private Savings in OECD Countries: A Panel Data Analysis

We investigate the cyclicality of the private savings to GDP ratio for a panel of 19 OECD countries over the period 1971-2009. We find robust evidence that the private savings ratio is countercyclical. Three theories unambiguously predict a higher private savings ratio during recessions: a Ricardian offset effect, the presence of credit constraints, and precautionary savings. We find evidence only for the latter theory. Our estimations take into account a large number of econometric complications: persistence in the savings ratio, endogeneity of the regressors, cross-country parameter heterogeneity, cross-sectional dependence, stationarity issues, omitted variables, and instrument strength.

World Equity Premium based Risk Aversion Estimates

The equity premium puzzle holds that the coefficient of relative risk aversion estimated from the consumption based CAPM under power utility is excessively high. Moreover, estimates in the literature vary considerably across countries. We gauge the uncertainty pertaining to the country risk aversion estimates by means of jackknife resampling and pooling. The confidence band for the world risk aversion estimate from the pooled country data is much tighter and the pooled point estimate presents less of a puzzle than the individual country estimates.

Idiosyncratic Labour Income Risk and Aggregate Consumption: An Unobserved Component Approach

We investigate the importance of aggregate and consumer-specific or idiosyncratic labour income risk for aggregate consumption changes in the US over the period 1952-2001. Theoretically, the effect of labour income risk on consumption changes is decomposed into an aggregate and into an idiosyncratic part. Empirically, aggregate risk is modelled through a GARCH process on aggregate labour income shocks and individual risk is modelled as an unobserved component and obtained through Kalman filtering. Our results suggest that aggregate labour income risk explains a negligible fraction of the variance of aggregate consumption changes. A more important part of aggregate consumption changes is explained by the unobserved component. The interpretation of this component as reflecting idiosyncratic labour income risk is supported by the finding that it is negatively affected by received consumer transfers. Idiosyncratic labour income risk thus matters for the aggregate economy.