COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 705R

"Consumption, Liquidity Constraints, and Asset Accumulation
in the Presence of Random Fluctuations"

Richard H. Clarida

May 1984
Revised July 1985

Recent empirical research, Flavin (1981), Hagashi (1982), has rejected the certainty-equivalent formulation of permanent income hypothesis, Hall (1978). These findings are often attributed to households’ inability to borrow completely against expected future labor income. This paper is a theoretical investigation of optimal consumption behavior under risk aversion, random income fluctuations, and borrowing restrictions. Our principle objective is to establish the existence and to investigate the properties of the stationary probability distribution which characterizes the asymptotic behavior of consumption under these conditions.

JEL Classification: 023

Keywords: Permanent income hypothesis, Optimal consumption behavior

See CFP 689