Superior Information Income Shocks and the Permanent Income Hypothesis 1998

Abstract:  According to the permanent income hypothesis with quadratic preferences, savings should react only to transitory income shocks, but not to permanent shocks. The problem is that income shock components are not separately observable. I show how the combination of income realizations with subjective expectations can help to identify separately the transitory and the permanent shock to income, thus providing a powerful test of the theory. The empirical analysis is performed on a sample of Italian households drawn from the 1989-1991 Survey of Household Income and Wealth. KEYWORDS: Subjective expectations, income shocks, permanent income hypothesis. JEL Classification: E21; D84; D91. 1 University College London and Istituto Universitario Navale, Napoli. I would like to thank Orazio Attanasio, Victoria Chick, Costas Meghir, Jonathan Parker and seminar participants in Tilburg. I am particularly grateful to Tullio Jappelli for providing very detailed comments on a preliminary version of th...