Author: Yingjie Niu, Yaoyao Wu, Siqi Zhao, Zhentao Zou

Abstract: We propose an intertemporal consumption-saving model by exploring the implications of the Law of Small Numbers (LSN), a belief heuristic stating that any sample realization of a population should be representative of the population. First, the existence of the LSN reduces the precautionary savings demand. More importantly, we show that the LSN belief structure provides an alternative explanation for two fundamental anomalies in consumption theory: 1) excess sensitivity by showing that past changes in income predict future changes in consumption; and 2) excess smoothness by lowering consumption volatility and generating the empirical magnitude.

Keywords: Law of Small Numbers；Consumption；Excess sensitivity；Excess smoothness

The article was published in August 2024 in issue 224 of "Journal of Economic Behavior & Organization," which is a Level B+ reward journal in the academic journal ranking scheme of the Economics and Management School of Wuhan University.

Link: https://www.sciencedirect.com/science/article/pii/S0167268124002397