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Is it really good to annuitize?

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  • Feigenbaum, James
  • Gahramanov, Emin
  • Tang, Xueli

Abstract

Although rational consumers without bequest motives are better off investing exclusively with annuitized instruments in partial equilibrium, we demonstrate the welfare effect of annuitization is ambiguous in general equilibrium on account of pecuniary externalities. Absent institutional constraints like prices and budgets, the optimal consumption rule would have marginal utility increase at the preferential discount rate. In a rational competitive equilibrium where households fully annuitize, the growth rate of marginal utility will be the discount rate minus the interest rate, resulting in a consumption profile that is too flat. Accidental bequests transfer wealth from the old to the young, steepening the consumption profile and yielding a better equilibrium. If households are restricted to Keynesian consumption functions, the optimal irrational equilibrium with standard preferences can replicate observed consumption and macroeconomic behavior, and the equilibrium without annuities delivers higher utility than the equilibrium with annuities. Whereas preceding papers have merely hypothesized that households might engage in socially optimal, yet irrational behavior, the failure of households to annuitize is a real-world example of this. Policymakers should not take steps to encourage more annuitization by the public.

Suggested Citation

  • Feigenbaum, James & Gahramanov, Emin & Tang, Xueli, 2013. "Is it really good to annuitize?," Journal of Economic Behavior & Organization, Elsevier, vol. 93(C), pages 116-140.
  • Handle: RePEc:eee:jeborg:v:93:y:2013:i:c:p:116-140
    DOI: 10.1016/j.jebo.2013.07.005
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    Cited by:

    1. Park, Hyeon & Feigenbaum, James, 2018. "Bounded rationality, lifecycle consumption, and Social Security," Journal of Economic Behavior & Organization, Elsevier, vol. 146(C), pages 65-105.
    2. Huang, H. & Milevsky, M.A. & Salisbury, T.S., 2017. "Retirement spending and biological age," Journal of Economic Dynamics and Control, Elsevier, vol. 84(C), pages 58-76.
    3. Johannes Hagen, 2015. "The determinants of annuitization: evidence from Sweden," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(4), pages 549-578, August.
    4. Heijdra, Ben J. & Mierau, Jochen O. & Trimborn, Timo, 2017. "Stimulating annuity markets," Journal of Pension Economics and Finance, Cambridge University Press, vol. 16(4), pages 554-583, October.
    5. Bagchi Shantanu & Feigenbaum James A., 2020. "Annuity Markets and Capital Accumulation," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 20(1), pages 1-10, January.
    6. Gahramanov, Emin, 2013. "Survival misperception, time inconsistency, and implications for life-cycle saving and welfare," Economic Modelling, Elsevier, vol. 32(C), pages 539-550.
    7. Gahramanov Emin, 2016. "On the Demographics and the Severity of the Social Security Crisis," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 16(2), pages 1001-1028, April.
    8. repec:dgr:rugsom:14015-eef is not listed on IDEAS
    9. Aleksandar Arandjelovi'c & Geoffrey Kingston & Pavel V. Shevchenko, 2023. "Life cycle insurance, bequest motives and annuity loads," Papers 2310.06274, arXiv.org.
    10. Arandjelović, Aleksandar & Kingston, Geoffrey & Shevchenko, Pavel V., 2023. "Life cycle insurance, bequest motives and annuity loads," Journal of Economic Dynamics and Control, Elsevier, vol. 157(C).
    11. Feigenbaum, James & Caliendo, Frank N., 2010. "Optimal irrational behavior in continuous time," Journal of Economic Dynamics and Control, Elsevier, vol. 34(10), pages 1907-1922, October.
    12. Gahramanov, Emin & Tang, Xueli, 2013. "A mixed blessing of lifespan heterogeneity," Journal of the Japanese and International Economies, Elsevier, vol. 29(C), pages 142-153.
    13. Erin Cottle Hunt & Frank N. Caliendo, 2022. "Social security and risk sharing: A survey of four decades of economic analysis," Journal of Economic Surveys, Wiley Blackwell, vol. 36(5), pages 1591-1609, December.
    14. Bachmann, Kremena & Lot, Andre & Xu, Xiaogeng & Hens, Thorsten, 2023. "Experimental Research on Retirement Decision-Making: Evidence from Replications," Journal of Banking & Finance, Elsevier, vol. 152(C).

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    More about this item

    Keywords

    Consumption; Saving; Coordination; Learning; General equilibrium; Pecuniary externalities; Annuities puzzle; Bequests; Mortality risk; Overlapping generations; Restricted optimal irrational behavior; Golden Rule;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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