Investment Decisions in Retirement: The Role of Subjective Expectations

38 Pages Posted: 15 Dec 2012

See all articles by Marco Angrisani

Marco Angrisani

Center for Economic and Social Research (CESR)

Michael D. Hurd

RAND Corporation; State University of New York at Stony Brook - College of Arts and Science - Department of Economics; National Bureau of Economic Research (NBER)

Erik Meijer

University of Southern California; RAND Corporation

Date Written: October 1, 2012

Abstract

The rapid transition from defined benefit (DB) pension plans to defined contribution (DC) plans has a potential benefit of offering pension holders greater control over how their pension accumulations are invested. If pension holders are willing to take some risk, investments in the stock market could increase their economic preparation for retirement, and, indeed, economic theory as well as the typical advice of financial advisors calls for stock market investments. Yet, the rate of stock holding is much below what theory suggests it should be, undoing any benefit associated with the greater control coming from DC plans. The leading explanations for this under-investing include excessive risk aversion, costs of entry, and misperceptions about possible returns in the stock market. We show that excessive risk aversion is not able to account for the low fraction of stock holding. However, a model with heterogeneous subjective expectations about stock market returns is able to account for low stock market participation, and tracks the share of risky assets conditional on participation reasonably well. Based on the model with subjective expectations, we estimate a welfare loss of up to 12% compared to investment under rational expectations, if actual returns follow the same distribution as in the past 50 years. The policy implication is that there is considerable scope for welfare improvement as a result of consumer education regarding stock market returns. However, the welfare loss is much smaller if individuals are not very risk averse or if actual returns follow the same distribution as in the past 10 years.

Keywords: retirement income, investment behavior, subjective expectations, pensions

Suggested Citation

Angrisani, Marco and Hurd, Michael D. and Meijer, Erik, Investment Decisions in Retirement: The Role of Subjective Expectations (October 1, 2012). Michigan Retirement Research Center Research Paper No. WP 2012-274. Available at SSRN: https://ssrn.com/abstract=2188403 or http://dx.doi.org/10.2139/ssrn.2188403

Marco Angrisani (Contact Author)

Center for Economic and Social Research (CESR) ( email )

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Michael D. Hurd

RAND Corporation ( email )

P.O. Box 2138
1776 Main Street
Santa Monica, CA 90407-2138
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310-393-0411 (Phone)
310-393-4818 (Fax)

State University of New York at Stony Brook - College of Arts and Science - Department of Economics ( email )

Stony Brook, NY 11794
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Erik Meijer

University of Southern California ( email )

635 Downey Way
Los Angeles, CA 90089-3332
United States

RAND Corporation ( email )

1776 Main Street
P.O. Box 2138
Santa Monica, CA 90407-2138
United States

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