Excess sensitivity and asymmetries in consumption: An empirical investigation

Most empirical studies on liquidity constraints classify a consumer as being constrained on the basis of a single indicator such as the asset-to-income ratio. In this analysis. we model the probability that a consumer faces liquidity constraints as a function of multiple social and economic factors. This probability function is estimated simultaneously with the degree of excess sensitivity of consumption to income in a switching regressions framework. The switching regressions apply optimal weights to the densities for the Euler equations in the two states and are less susceptible to sample misclassification. Our results based on data from the CEX confirm that liquidity-constrained consumers are excessively sensitive to variables already known to economic agents. However. there is also evidence that the unconstrained consumers exhibit behavior that is inconsistent with the theoretical predictions. Further analysis suggests that such behavior could be explained by time-nonseparable preferences.