The Annuity Duration Puzzle

52 Pages Posted: 15 Mar 2012  

Narat Charupat

McMaster University - DeGroote School of Business

Mark J. Kamstra

York University - Schulich School of Business

Moshe A. Milevsky

York University - Schulich School of Business

Date Written: March 14, 2012

Abstract

We test whether life-contingent annuity prices promptly and fully adjust to changes in interest rates; a standard assumption made implicitly or explicitly in a growing annuity literature. Using a unique database consisting of over 3 million U.S. annuity quotes, we find that prices do not move as one might expect. Rather, prices adjust gradually and over a period of several weeks and often months, in response to certain -- and not necessarily riskless -- interest rate changes. In particular, we find that changes to the 30-year U.S. mortgage rate provide a better fit and indication of where annuity payouts are headed, compared to the 10-year swap rate, for example. In addition, we find that the sensitivity to interest rate changes (a.k.a. annuity duration) is asymmetric. Annuity prices react more rapidly and with greater sensitivity to an increase in the relevant interest rate compared to a decrease. Overall our findings are inconsistent with a financial economic view of a life annuity as a risk-free bond-like instrument, plus mortality credits. We believe that we are the first to examine the dynamic microstructure of annuity prices and that our results have implications for a wide swath of existing literature. This includes portfolio choice at retirement, the optimal timing of annuitization, the money's worth ratio, the inference of mortality expectations from insurance prices as well as the valuation of pension liabilities.

Keywords: Retirement, Pensions, Lifecycle, Portfolio Choice, Insurance, Mortality

JEL Classification: D14, D91, G11

Suggested Citation

Charupat, Narat and Kamstra, Mark J. and Milevsky, Moshe A., The Annuity Duration Puzzle (March 14, 2012). Available at SSRN: https://ssrn.com/abstract=2021579 or http://dx.doi.org/10.2139/ssrn.2021579

Narat Charupat

McMaster University - DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
(905) 525-9140 ext. 23987 (Phone)

Mark J. Kamstra

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

Moshe Arye Milevsky (Contact Author)

York University - Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

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