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ICC Advance Access published online on October 17, 2008
Industrial and Corporate Change, doi:10.1093/icc/dtn039
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© The Author 2008. Published by Oxford University Press on behalf of Associazione ICC. All rights reserved.

Excess sensitivity of consumption to income growth: a model of Loss Aversion*

Giacomo Pasini

The article provides an empirical test on micro-data of a model of individual behavior based on Loss Aversion: utility is S-shaped, i.e. concave above reference consumption and convex below it. As a consequence individuals do not reduce current consumption in response to an expected income decline as long as uncertainty is high enough. Such a behavior is consistent with excess sensitivity of consumption to income growth, an empirical regularity which is hard to explain within a standard Life Cycle model. Loss Aversion is tested on an Italian dataset (the Bank of Italy's; Survey on Households' Income and Wealth). The conclusion is that excess sensitivity could be explained by a model that do not assume individuals to be expected utility maximizers.

*The first version of this article was written while visiting the Economics Department at Stanford University during my PhD.


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