Parameter Assumptions in Normative Analyses of Household Financial Decisions

Normative analyses of household financial decisions typically assume parameters of the household utility function. Some general issues on parameter assumptions for normative analysis are discussed in this study. We review selected normative household analyses appearing in finance and economics journals, examine the parameters assumed for risk aversion, intertemporal elasticity, and personal discount rates, and discuss justifications authors presented for the parameter values assumed. Moreover, articles cited in the normative articles for justification of utility function parameter values, and some other articles that have provided estimates of household parameter values are examined. None of the normative articles cited an independent estimate of the personal discount rate, instead, arbitrary assumptions were made for the discount rate. Most of the sources cited for relative risk aversion and for intertemporal elasticity had estimates based on aggregate patterns. We conclude with recommendations for parameter assumptions in normative analyses of household financial decisions