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Cognitive Constraints on Valuing Annuities

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  • Jeffrey R. Brown
  • Arie Kapteyn
  • Erzo F.P. Luttmer
  • Olivia S. Mitchell

Abstract

We show that people have difficulty valuing annuities, and this, instead of a preference for lumpsums, helps explain observed low annuity demand. Although the median price at which people are willing to sell an annuity stream is close to the actuarial value, many responses diverge greatly from optimizing behavior. Moreover, people will pay substantially less to buy than to sell annuities. We conclude that boundedly rational consumers adopt "buy low, sell high" heuristics when confronting a complex trade-off. This suggests that many consumers do not make optimizing decisions, underscoring the difficulty of explaining cross-sectional annuity valuation differences using standard models.

Suggested Citation

  • Jeffrey R. Brown & Arie Kapteyn & Erzo F.P. Luttmer & Olivia S. Mitchell, 2013. "Cognitive Constraints on Valuing Annuities," NBER Working Papers 19168, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19168
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    Cited by:

    1. Teresa Bago d'Uva & Esen Erdogan Ciftci & Owen O'Donnell & Eddy van Doorslaer, 2015. "Who can predict their Own Demise? Accuracy of Longevity Expectations by Education and Cognition," Tinbergen Institute Discussion Papers 15-052/V, Tinbergen Institute.

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    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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