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Optimal decision of dynamic wealth allocation with life insurance for mitigating health risk under market incompleteness

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  • Chen, Chang-Chih
  • Chang, Chia-Chien
  • Sun, Edward W.
  • Yu, Min-Teh

Abstract

This research proposes a dynamic control modeling of income allocation between life insurance purchase and consumption subject to market incompleteness. We adopt a no-good-deal specification of the multiplicity of stochastic discount factors, and treat death as a stopping time on the individual’s health status. Health status non-tradability renders death risk non-hedgeable and the life insurance market incomplete. The no-good-deal condition provides useful guidance for individuals to choose the insurance-income ratio inside good-deal bounds. The magnitude of the influence of market incompleteness on life insurance demand (measured as the width of good-deal bounds) displays life-cycle patterns that converge over time and are highly sensitive to health status characteristics.

Suggested Citation

  • Chen, Chang-Chih & Chang, Chia-Chien & Sun, Edward W. & Yu, Min-Teh, 2022. "Optimal decision of dynamic wealth allocation with life insurance for mitigating health risk under market incompleteness," European Journal of Operational Research, Elsevier, vol. 300(2), pages 727-742.
    • Handle: RePEc:eee:ejores:v:300:y:2022:i:2:p:727-742
    DOI: 10.1016/j.ejor.2021.10.016
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    4. Chen, An & Ferrari, Giorgio & Zhu, Shihao, 2023. "Striking the Balance: Life Insurance Timing and Asset Allocation in Financial Planning," Center for Mathematical Economics Working Papers 684, Center for Mathematical Economics, Bielefeld University.

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