Consumption Commitments and Preferences for Risk

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  • 1 January 2004
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      • Published in RePEc
Abstract
We examine an economy in which the cost of consuming some goods can be reduced by making commitments to consumption levels that do not vary across states. For example, moral hazard and matching considerations may make it cheaper to produce housing services via owner-occupied than rented housing, but the transactions costs associated with the former may compel consumers to adopt a realtively inflexible housing consumptin plan. We show that consumption commitments can cause risk-neutral consumers to care a great deal about risk, creating an incentive to insure risks and to bunch uninsured risks together. As a result, workers may preger to avoid wage risk while bearing an unemployment risk that is concentrated in as few states as possible. The interaction between consumptin and labor markets may give rise to multiple equilibria. The basic predictions of the model are compared with corresponding moments of US data on layoff risk and housing consumption.

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