Journal of Economics and Finance

, Volume 35, Issue 1, pp 41–70

Can overconfidence explain the consumption hump?

A general equilibrium inquiry
Article

DOI: 10.1007/s12197-009-9082-6

Cite this article as:
Bagchi, S. J Econ Finan (2011) 35: 41. doi:10.1007/s12197-009-9082-6

Abstract

The standard neoclassical life-cycle model predicts that individual consumption should either increase, remain constant or fall monotonically depending on whether the market rate of return on savings is greater than, equal to or less than the discount rate. However, empirical evidence suggests that even after controlling for economic growth and family size, household consumption exhibits a robust hump at around age 45–55, with the ratio of peak consumption to consumption when entering the workforce greater than 1.1. This paper extends the “overconfidence” explanation (Caliendo and Huang, J. Macroecon 30(4):1347–1369, 2008) of this macroeconomic puzzle to a calibrated general equilibrium environment. The main finding is that although it is possible to identify parameter values under which overconfidence alone generates life-cycle consumption profiles and macro-indicators consistent with U.S. experience, quite extreme assumptions about both the magnitude and distribution of overconfidence in the population are generally required to obtain them.

Keywords

Overconfidence Bounded Rationality Life-Cycle Consumption Hump-Shape General Equilibrium 

JEL Classification

D58 D91 E21 

Copyright information

© Springer Science+Business Media, LLC 2009

Authors and Affiliations

  1. 1.Applied Economics DepartmentUtah State UniversityLoganUSA

Personalised recommendations