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Optimal Annuitization with Stochastic Mortality Probabilities

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  • Felix Reichling
  • Kent Smetters

Abstract

The conventional wisdom dating back to Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Numerous market frictions do not break this sharp result. We modify the Yaari framework by allowing a household's mortality risk itself to be stochastic. Annuities still help to hedge longevity risk, but they are now subject to valuation risk. Valuation risk is a powerful gateway mechanism for numerous frictions to reduce annuity demand, even without ad hoc "liquidity constraints." We find that most households should not annuitize any wealth. The optimal level of aggregate net annuity holdings is likely even negative.

Suggested Citation

  • Felix Reichling & Kent Smetters, 2013. "Optimal Annuitization with Stochastic Mortality Probabilities," NBER Working Papers 19211, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19211
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    References listed on IDEAS

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    1. Lee M. Lockwood, 2014. "Incidental Bequests and the Choice to Self-Insure Late-Life Risks," NBER Working Papers 20745, National Bureau of Economic Research, Inc.
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    9. Menahem E. Yaari, 1965. "Uncertain Lifetime, Life Insurance, and the Theory of the Consumer," Review of Economic Studies, Oxford University Press, vol. 32(2), pages 137-150.
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    13. Shinichi Nishiyama, 2002. "Bequests, Inter Vivos Transfers, and Wealth Distribution," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(4), pages 892-931, October.
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    15. Cassio M. Turra & Olivia S. Mitchell, 2004. "The Impact of Health Status and Out-of-Pocket Medical Expenditures on Annuity Valuation," Working Papers wp086, University of Michigan, Michigan Retirement Research Center.
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    Cited by:

    1. John Laitner & Daniel Silverman & Dmitriy Stolyarov, 2014. "Annuitized Wealth and Post-Retirement Saving," NBER Working Papers 20547, National Bureau of Economic Research, Inc.
    2. Felix Reichling & Kent Smetters, 2015. "Optimal Annuitization with Stochastic Mortality and Correlated Medical Costs," American Economic Review, American Economic Association, vol. 105(11), pages 3273-3320, November.
    3. Jeffrey R. Brown & Jeffrey R. Kling & Sendhil Mullainathan & Marian V. Wrobel, 2013. "Framing Lifetime Income," NBER Working Papers 19063, National Bureau of Economic Research, Inc.
    4. repec:oup:jeurec:v:15:y:2017:i:2:p:429-462. is not listed on IDEAS
    5. Jeffrey R. Brown & Arie Kapteyn & Erzo F.P. Luttmer & Olivia S. Mitchell, 2017. "Cognitive Constraints on Valuing Annuities," Journal of the European Economic Association, European Economic Association, vol. 15(2), pages 429-462.

    More about this item

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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