Precautionary Savings and Partially Observed Income

Abstract

I propose an intertemporal precautionary-saving model in which the agent's labor income is subject to both permanent and transitory shocks. However, he only observes his total income, not individual components. I show that partial observability of individual components of income gives rise to additional precautionary saving because of uncertainty in estimating individual components of income. This additional precautionary saving is higher, when there is greater uncertainty associated with estimating the individual components of income. Incomplete Information, Kalman Filter