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Capital Accumulation and Uncertain Lifetimes with Adverse Selection

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  • Andrew B. Abel

Abstract

This paper examines the implications of adverse selection in the private annuity market for the pricing of private annuities and the consequent effects on constrption and bequest behavior. With privately known heterogeneous mortality probabilities, adverse selection causes the rate of return on private annuities to be less than the actuarially fair rate based on population average mortality. However, a fully funded social security system with compulsory participation can offer an implied rate of return equal to the actuarially fair rate based on population average mortality. Thus, since social security offers a higher rate of return than private annuities, consumers cannot completely offset the effects of social security by transacting in the private annuity market. Using an overlapping generations model with uncertain lifetimes, we demonstrate that the introduction of actuarially fair social security reduces the steady state rate of return on annuities and raises the steady state levels of average bequests and average consumption of the young. The steady state national capital stock rises or falls according to the strength of the bequest motive.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1664.

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Date of creation: Jul 1985
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Publication status: published as Abel, Andrew B. "Capital Accumulation and Uncertain Lifetimes with Adverse Selection." Econometrica, Vol. 54, No. 5, (September 1986), pp. 1079-1097.
Handle: RePEc:nbr:nberwo:1664

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  1. Richard, Scott F., 1975. "Optimal consumption, portfolio and life insurance rules for an uncertain lived individual in a continuous time model," Journal of Financial Economics, Elsevier, Elsevier, vol. 2(2), pages 187-203, June.
  2. Laurence J. Kotlikoff & Avia Spivak, 1979. "The Family as an Incomplete Annuities Market," NBER Working Papers 0362, National Bureau of Economic Research, Inc.
  3. Fischer, Stanley, 1973. "A Life Cycle Model of Life Insurance Purchases," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 14(1), pages 132-52, February.
  4. Eckstein, Zvi & Eichenbaum, Martin S & Peled, Dan, 1985. "The Distribution of Wealth and Welfare in the Presence of Incomplete Annuity Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(3), pages 789-806, August.
  5. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  6. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(4), pages 630-49, November.
  7. Barro, Robert J. & Friedman, James W., 1977. "On Uncertain Lifetimes," Scholarly Articles 3451301, Harvard University Department of Economics.
  8. Levhari, David & Mirman, Leonard J, 1977. "Savings and Consumption with an Uncertain Horizon," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(2), pages 265-81, April.
  9. Sheshinski, Eytan & Weiss, Yoram, 1981. "Uncertainty and Optimal Social Security Systems," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 96(2), pages 189-206, May.
  10. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 66, pages 467.
  11. Abel, Andrew B, 1985. "Precautionary Saving and Accidental Bequests," American Economic Review, American Economic Association, American Economic Association, vol. 75(4), pages 777-91, September.
  12. Drazen, Allan, 1978. "Government Debt, Human Capital, and Bequests in a Life-Cycle Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 86(3), pages 505-16, June.
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