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Extending Life Cycle Models of Optimal Portfolio Choice: Integrating Flexible Work, Endogenous Retirement, and Investment Decisions with Lifetime Payouts

Listed author(s):
  • Jingjing Chai

    (Goethe University)

  • Wolfram Horneff

    (Goethe University)

  • Raimond Maurer

    (Goethe University)

  • Olivia S. Mitchell

    (The Wharton School)

This paper derives optimal life cycle portfolio asset allocations as well as annuity purchases trajectories for a consumer who can select her hours of work and also her retirement age. Using a realistically-calibrated model with stochastic mortality and uncertain labor income, we extend the investment universe to include not only stocks and bonds, but also survival-contingent payout annuities. We show that making labor supply endogenous raises older peoples’ equity share; substantially increases work effort by the young; and markedly enhances lifetime welfare. Also, introducing annuities leads to earlier retirement and higher participation by the elderly in financial markets. Finally, when we allow for an age-dependent leisure preference parameter, this fits well with observed evidence in that it generates lower work hours and smaller equity holdings at older ages as well as sensible retirement age patterns.

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File URL: http://www.mrrc.isr.umich.edu/publications/Papers/pdf/wp204.pdf
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Paper provided by University of Michigan, Michigan Retirement Research Center in its series Working Papers with number wp204.

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Length: 34 pages
Date of creation: Aug 2009
Handle: RePEc:mrr:papers:wp204
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Web page: http://www.mrrc.isr.umich.edu/publications/papers/
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  1. Gomes, Francisco J & Michaelides, Alexander, 2005. "Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence," CEPR Discussion Papers 4853, C.E.P.R. Discussion Papers.
  2. Zvi Bodie & Robert C. Merton & William F. Samuelson, 1992. "Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model," NBER Working Papers 3954, National Bureau of Economic Research, Inc.
  3. John Y. CAMPBELL & Luis VICEIRA, 1998. "Who Should Buy Long-Term Bonds?," FAME Research Paper Series rp5, International Center for Financial Asset Management and Engineering.
  4. Bodie, Zvi & Detemple, Jerome B. & Otruba, Susanne & Walter, Stephan, 2004. "Optimal consumption-portfolio choices and retirement planning," Journal of Economic Dynamics and Control, Elsevier, vol. 28(6), pages 1115-1148, March.
  5. Brown, Jeffrey R. & Mitchell, Olivia S. & Poterba, James M. & Warshawsky, Mark J., 1999. "Taxing Retirement Income: Nonqualified Annuities and Distributions From Qualified Accounts," National Tax Journal, National Tax Association, vol. 52(3), pages 563-592, September.
  6. Gustman, Alan L. & Steinmeier, Thomas L., 2005. "The social security early entitlement age in a structural model of retirement and wealth," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 441-463, February.
  7. Campbell, John Y & Chan, Yeung Lewis & Viceira, Luis M, 2001. "A Multivariate Model of Strategic Asset Allocation," CEPR Discussion Papers 3070, C.E.P.R. Discussion Papers.
  8. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," NBER Working Papers 8074, National Bureau of Economic Research, Inc.
  9. Francisco J. Gomes & Laurence J. Kotlikoff & Luis M. Viceira, 2008. "Optimal Life-Cycle Investing with Flexible Labor Supply: A Welfare Analysis of Life-Cycle Funds," NBER Working Papers 13966, National Bureau of Economic Research, Inc.
  10. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchel & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," Working Papers wp177, University of Michigan, Michigan Retirement Research Center.
  11. Ranguelova, Elena & Feldstein, Martin, 2001. "Individual Risk in an Investment-Based Social Security System," Scholarly Articles 2797440, Harvard University Department of Economics.
  12. Hamish Low, 2005. "Self-Insurance in a Life-Cycle Model of Labor Supply and Savings," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(4), pages 945-975, October.
  13. Horneff, Wolfram J. & Maurer, Raimond H. & Mitchell, Olivia S. & Dus, Ivica, 2008. "Following the rules: Integrating asset allocation and annuitization in retirement portfolios," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 396-408, February.
  14. Luis M. Viceira, 1999. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," NBER Working Papers 7409, National Bureau of Economic Research, Inc.
  15. Hurd, Michael D, 1989. "Mortality Risk and Bequests," Econometrica, Econometric Society, vol. 57(4), pages 779-813, July.
  16. Milevsky, Moshe A. & Young, Virginia R., 2007. "Annuitization and asset allocation," Journal of Economic Dynamics and Control, Elsevier, vol. 31(9), pages 3138-3177, September.
  17. Courtney Coile & Peter Diamond & Jonathan Gruber & Alain Jousten, 1999. "Delays in Claiming Social Security Benefits," NBER Working Papers 7318, National Bureau of Economic Research, Inc.
  18. Olivia S. Mitchell, 1999. "New Evidence on the Money's Worth of Individual Annuities," American Economic Review, American Economic Association, vol. 89(5), pages 1299-1318, December.
  19. Farhi, Emmanuel & Panageas, Stavros, 2007. "Saving and investing for early retirement: A theoretical analysis," Journal of Financial Economics, Elsevier, vol. 83(1), pages 87-121, January.
  20. Olivia S. Mitchell & John W.R. Phillips, 2006. "Social Security Replacement Rates for Alternative Earnings Benchmarks," Working Papers wp116, University of Michigan, Michigan Retirement Research Center.
  21. Moshe A. Milevsky & Kristen S. Moore & Virginia R. Young, 2006. "Asset Allocation And Annuity-Purchase Strategies To Minimize The Probability Of Financial Ruin," Mathematical Finance, Wiley Blackwell, vol. 16(4), pages 647-671.
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  24. H. Benitez-Silva & F. Heiland, 2008. "Early claiming of social security benefits and labour supply behaviour of older Americans," Applied Economics, Taylor & Francis Journals, vol. 40(23), pages 2969-2985.
  25. Horneff, Wolfram J. & Maurer, Raimond H. & Stamos, Michael Z., 2008. "Life-cycle asset allocation with annuity markets," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3590-3612, November.
  26. Rui Yao, 2005. "Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 197-239.
  27. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchell & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," NBER Working Papers 14055, National Bureau of Economic Research, Inc.
  28. Eric French, 2000. "The effects of health, wealth, and wages on labor supply and retirement behavior," Working Paper Series WP-00-2, Federal Reserve Bank of Chicago.
  29. Joao F. Cocco, 2005. "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 491-533.
  30. Jeffrey R. Brown & Olivia S. Mitchell & James M. Poterba & Mark J. Warshawsky, 1999. "Taxing Retirement Income: Nonqualified Annuities and Distributions from Qualified Accounts," NBER Working Papers 7268, National Bureau of Economic Research, Inc.
  31. Gary S. Fields & Olivia S. Mitchell, 1984. "Retirement, Pensions, and Social Security," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262060914, September.
  32. Valery Polkovnichenko, 2007. "Life-Cycle Portfolio Choice with Additive Habit Formation Preferences and Uninsurable Labor Income Risk," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 83-124, January.
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