Income Risk, Precautionary Saving, and Loss Aversion – An Empirical Test

Abstract

This paper empirically examines the behavioral precautionary saving hypothesis by Kőszegi and Rabin (2009) stating that uncertainty about future income triggers sav- ing because of loss aversion. We extend their theoretical analysis and empirically study the relation between income risk, experimentally elicited loss aversion and precautionary savings among a sample of 640 individuals from the low-income population, character- ized by limited financial education and subject to substantial income risk. In line with the theoretical predictions, we find that an increase in income risk is associated with higher savings for loss-averse individuals, and that this increase in savings grows with the degree of loss aversion. Our findings establish that loss aversion is, contrarily to common assumptions, not necessarily an obstacle to saving, and depict approaches of increasing saving among individuals with low financial education

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