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

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.