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Fertility and Consumption when Having a Child is a Risky Investment

Gete, Pedro and Porchia, Paolo (2010): Fertility and Consumption when Having a Child is a Risky Investment.

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Abstract

In this paper we study a new factor that matters for fertility and consumption decisions: the risks associated with having and raising a child. We analyze a real options model with incomplete markets to explicitly model both children as a risky investment and the parental option to time fertility. We focus on CRRA preferences and uninsurable shocks to future parental income and to the costs of raising a child. We obtain several results that are new relative to the standard Beckerian fertility framework where children are deterministic goods: i) Independently of wealth, higher child cost volatility diminishes fertility. ii) Consumption is decreasing in higher cost volatility but the slope flattens as wealth increases. iii) Wealth alters the way in which the agent's risk tolerance impacts the fertility and consumption decisions. For low wealth levels, risk aversion speeds up fertility and lowers consumption with children serving as an utility insurance mechanism. iv) Fertility is increasing in the correlation between income and child cost shocks. v) The sign of this correlation determines if higher income volatility speeds up or delays fertility. vi) Fertility is U-shaped in the income over wealth ratio. Finally, we use regression analysis to provide empirical support for the theoretical results.

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