Liquidity Constraints, Income Variance, and Buffer Stock Savings: Experimental Evidence

Abstract

We test the buffer stock model of savings behavior using a three‐period intertemporal model. In one treatment, liquidity in the second period is constrained (borrowing not possible), while the unconstrained treatment has no such constraint. The buffer stock model predicts that a second‐period liquidity constraint increases first‐period savings. We also vary the variance of stochastic income (high or low) in a 2×2$2 \times 2$ design. While we find no evidence for the predicted liquidity constraint effect, most other predictions hold, for example, income variance effects. Observed departures can be explained by some combination of debt aversion, cognitive heterogeneity, and/or learning.