How Prudent are Consumers?

Using data from the Consumer Expenditure Survey, this paper presents a simple test that provides an explicit estimate of the parameter in the utility function that reflects the strength of the precautionary saving motive, the coefficient of relative prudence. The test yields a fairly precise estimate of a small precautionary motive; in fact, the estimate is too small to be consistent with widely accepted beliefs about risk aversion. The presence of liquidity-constrained households does not appear to explain this finding, and there is some evidence that self-selection of households into risky environments also cannot explain the results.