Precautionary Saving in the Small and in the Large

Abstract

The theory of precautionary saving is shown in this paper to be isomorphic to the Arrow-Pratt theory of risk aversion, making possible the application of a large body of knowledge about risk aversion to precautionary saving, and more generally, to the theory of optimal choice under risk. In particular, a measure of the strength of precautionary saving motive analogous to the Arrow-Pratt measure of risk aversion is used to establish a number of new propositions about precautionary saving, and to give a new interpretation of the Oreze-Modigliani substitution effect.