How Significant are Departures from Certainty Equivalence? Some Analytical and Empirical Results

The feedback and the autoregressive closed form solution of the consumption function, with the income process allowed to follow a general ARIMA stochastic process, for the quadratic, exponential and Weil's hybrid exponential-isoelastic utility functions are compared. For the exponential and Weil's utility functions, the consumption function can be decomposed into a certainty equivalent term plus a precautionary saving term. The three utility functions behave similarly when the consumer's subjective rate of time preference equals the market interest rate. Deviations from certainty equilvalence become apparent only when consumers are allowed to have a different degree of patience than the market. (Copyright: Elsevier)