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Behavioral Biases in Annuity Choice: An Experiment

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Abstract

We conduct a neutral-context laboratory experiment to systematically investigate the role of the hit-by-bus concern in explaining the annuitization puzzle: the low rate of retirement-asset annuitization relative to the predictions of standard models. We vary endowed asset (annuity vs. stock of wealth vs. no explicit endowment), and find a strong endowment effect. Furthermore, we find that the ordering of survival risks matters. Compared to a frame in which a single draw from a known distribution determines survival outcome, annuity choice is lower when subjects must sequentially survive early periods to reach periods in which the annuity dominates. We conclude with policy implications.

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File URL: http://web.williams.edu/Economics/wp/gazzaleAnnuityChoice20090325.pdf
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Paper provided by Department of Economics, Williams College in its series Department of Economics Working Papers with number 2009-01.

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Length: 37 pages
Date of creation: Mar 2009
Handle: RePEc:wil:wileco:2009-01
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Keywords: experimental economics; behavioral; retirement; annuities;

Find related papers by JEL classification:

  • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
  • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
  • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
  • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
  • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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  1. Kotlikoff, Laurence J & Spivak, Avia, 1981. "The Family as an Incomplete Annuities Market," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 372-391, April.
  2. Dushi, Irena & Webb, Anthony, 2004. "Household annuitization decisions: simulations and empirical analyses," Journal of Pension Economics and Finance, Cambridge University Press, vol. 3(02), pages 109-143, July.
  3. 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.
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  5. Enrique Fatas & Juan A. Lacomba & Francisco Lagos, 2007. "An Experimental Test On Retirement Decisions," Economic Inquiry, Western Economic Association International, vol. 45(3), pages 602-614, 07.
  6. Mariacristina De Nardi & Eric French & John Bailey Jones, 2005. "Differential mortality, uncertain medical expenses, and the saving of elderly singles," Working Paper Series WP-05-13, Federal Reserve Bank of Chicago.
  7. Wojciech Kopczuk & Joseph P. Lupton, 2007. "To Leave or Not to Leave: The Distribution of Bequest Motives," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 207-235.
  8. James M. Poterba & Steven F. Venti & David A. Wise, 2008. "New Estimates of the Future Path of 401(k) Assets," NBER Chapters,in: Tax Policy and the Economy, Volume 22, pages 43-80 National Bureau of Economic Research, Inc.
  9. Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December.
  10. Benjamin M. Friedman & Mark Warshawsky, 1985. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
  11. Eytan Sheshinski, 2007. "The Economic Theory of Annuities," Economics Books, Princeton University Press, edition 1, number 8536.
  12. 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.
  13. Alicia H. Munnell, 2003. "The Declining Role Of Social Security," Just the Facts jtf-6, Center for Retirement Research.
  14. V. Kerry Smith & Donald H. Taylor & Frank A. Sloan, 2001. "Longevity Expectations and Death: Can People Predict Their Own Demise?," American Economic Review, American Economic Association, vol. 91(4), pages 1126-1134, September.
  15. David Laibson, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, Oxford University Press, vol. 112(2), pages 443-478.
  16. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  17. 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.
  18. Shane Frederick & George Loewenstein & Ted O'Donoghue, 2002. "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 40(2), pages 351-401, June.
  19. Thomas Davidoff & Jeffrey R. Brown & Peter A. Diamond, 2005. "Annuities and Individual Welfare," American Economic Review, American Economic Association, vol. 95(5), pages 1573-1590, December.
  20. Benjamin M. Friedman & Mark J. Warshawsky, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 135-154.
  21. Diamond, Peter & Koszegi, Botond, 2003. "Quasi-hyperbolic discounting and retirement," Journal of Public Economics, Elsevier, vol. 87(9-10), pages 1839-1872, September.
  22. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
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Cited by:

  1. Peijnenburg, J.M.J. & Nijman, T.E. & Werker, B.J.M., 2010. "Optimal Annuitization with Incomplete Annuity Markets and Background Risk During Retirement," Discussion Paper 2010-11, Tilburg University, Center for Economic Research.
  2. Peijnenburg, J.M.J. & Nijman, T.E. & Werker, B.J.M., 2010. "Health Cost Risk and Optimal Retirement Provision : A Simple Rule for Annuity Demand," Discussion Paper 2010-14, Tilburg University, Center for Economic Research.
  3. Enrique Fatás & Juan Lacomba & Francisco Lagos & Ana Moro-Egido, 2013. "An experimental test on dynamic consumption and lump-sum pensions," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 4(4), pages 393-413, November.

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