Stock Market Returns and Annuitization: A Case of Myopic Extrapolation

40 Pages Posted: 21 Mar 2011  

Alessandro Previtero

Indiana University - Kelley School of Business - Department of Finance

Date Written: February 15, 2011

Abstract

Managing retirement wealth is one of the major financial decisions that individuals face. In this setting, I document a strong negative relationship between stock market returns and annuitization. Using a novel dataset with more than 103,000 actual payout decisions, I find that positive stock market returns decrease the likelihood of employees choosing an annuity over a lump sum, and vice versa. More precisely, only recent market performance drives annuitization with almost no weight assigned to returns two years before the decision date. Several explanations can account for these findings: wealth effects generated by movements of the stock market; endogenous timing of retirement; volatility of stock market returns and time varying risk aversion; and expectations about labor income or inflationary periods. After addressing these explanations, I present evidence consistent with employees extrapolating from recent stock market returns. I conclude showing that this myopic extrapolation - based on very recent stock market performance - can bear serious welfare consequence and significantly reduce retirement wealth if, for example, individuals annuitize too early because of a market drop.

Keywords: Annuities, Myopic Extrapolation, Wealth Effects, Household Finance, Behavioral Finance

JEL Classification: D14, G11, G22, H55

Suggested Citation

Previtero, Alessandro, Stock Market Returns and Annuitization: A Case of Myopic Extrapolation (February 15, 2011). Available at SSRN: https://ssrn.com/abstract=1787123 or http://dx.doi.org/10.2139/ssrn.1787123

Alessandro Previtero (Contact Author)

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
+1 (512) 581-5420 (Phone)

HOME PAGE: http://aleprevitero.com

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