On the proportionality and homogeneity of consumption and income

In its certainty equivalence form, consumption is proportional to the sum of human and non-human wealth. With labour income uncertainty the proportionality takes the form of homogeneity of consumption with respect to the components of wealth. In this paper the authors analyse the stochastic properties of labour income that yield the homogeneity property as the utility-maximizing solution. A sufficient conditions is derived on the way in which a certain income shift preserves the homogeneity property. This condition can hold for some geometric processes where the logarithm of labour income is modelled as ARMA (k,l). For other income processes the response of consumption to a certain income innovation may be larger, which appears as excess sensitivity. -Author