Precautionary Savings and Self-Selection: Evidence from the German Reunification "Experiment"

We combine particular features of the German civil service with the unique event of German reunification to test the theory of precautionary savings and to quantify the importance of self-selection into occupations due to differences in risk aversion. In the presence of self-selection, failing to control for risk aversion in empirical tests of precautionary savings results in a bias that could lead to a systematic underestimation of the importance of precautionary savings. We exploit the fact that for individuals from the former German Democratic Republic (GDR) German reunification in 1990 caused an exogenous reassignment of income risks. Our findings suggest that self-selection of risk-averse individuals into low-risk occupations is economically important and decreases aggregate precautionary wealth holdings significantly. © 2005 MIT Press