BUFFER STOCKS AND PRECAUTIONARY SAVINGS WITH LOSS AVERSION

This paper reexamines buffer stocks and precautionary savings in the p resence of loss aversion. We assume that agents are disappointment ave rse, as in Gul [Econometrica, 59 (1991) 667-686]. We show that the con cavity of the marginal utility continues to determine precautionary sa ving, but its effect is of a second order magnitude (proportional to t he square of the coefficient of variation) compared to the first order effect (proportional to the coefficient of variation) induced by loss aversion. We show that a stabilization fund that is rather small when agents are maximizing the conventional expected utility, turns out to be rather large with loss aversion. (C) 1998 Elsevier Science Ltd. Al l rights reserved.