Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses
38 Pages Posted: 20 Dec 2007 Last revised: 28 Sep 2009
Date Written: December 1, 2007
This paper derives optimal equity-bond-annuity portfolios for households who face stochastic capital market returns, differential exposures to mortality risk and uncertain uninsured health expenses, and differential Social Security and defined benefit pension coverage. The results show that the health spending risk drives household portfolios to shift from risky equities to safer assets and enhances the demand for annuities due to their increasing-with-age superiority over bonds in hedging against life-contingent health spending and longevity risks. Households with higher income have a greater incremental demand for life annuities. The safe and higher-return annuities in turn provide a greater leverage for equity investment in the remaining asset portfolios.
Keywords: annuity, asset allocation, health expense, precautionary savings, Social Security, pension, lifecycle
JEL Classification: D12, D31, D91, G11, H55, I10, J32
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