Rethinking Optimal Wealth Accumulation and Decumulation Strategies in the Wake of the Financial Crisis

Center for Retirement Research at Boston College CRR WP 2013-1

23 Pages Posted: 4 Jan 2013

See all articles by Richard Kopcke

Richard Kopcke

Boston College - Center for Retirement Research

Anthony Webb

Boston College - Center for Retirement Research

Joshua Hurwitz

Boston College - Center for Retirement Research

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2013

Abstract

A substantial literature has developed models of optimal consumption and asset allocation based on the assumption that stocks and bonds have fixed returns, with normal independent, identically distributed disturbances. Households optimally rebalance from stocks to bonds as they age, reflecting the declining proportion of their wealth that is represented by low-risk human capital.

Using annual return data for large-capitalization stocks and corporate bonds covering the period 1926 through 2011, the paper calculates optimal consumption and asset allocation over the life cycle for a household with Social Security benefits and uncertain labor market earnings. It considers the alternative assumptions that stock and bond returns 1) are normally distributed, 2) follow a vector autoregressive path (VAR) with normally distributed disturbances, and 3) follow a VAR with disturbances drawn from a stable distribution. The assumptions have a significant effect on asset allocation. At age 65, the optimal stock allocation is 52 percent, 68 percent, and 55 percent, respectively, for the three alternatives. When returns follow a VAR with stable disturbances, a household with a constant relative risk aversion assuming a coefficient of risk aversion of 2 would require a 1 percent increase in lifetime consumption to compensate it for assuming that the disturbances to returns follow a normal distribution. Households with a coefficient of risk aversion of 5 would require less than 0.1 percent, reflecting their lower accumulation of wealth and smaller stock allocations.

Suggested Citation

Kopcke, Richard and Webb, Anthony and Hurwitz, Joshua, Rethinking Optimal Wealth Accumulation and Decumulation Strategies in the Wake of the Financial Crisis (January 1, 2013). Center for Retirement Research at Boston College CRR WP 2013-1. Available at SSRN: https://ssrn.com/abstract=2196059 or http://dx.doi.org/10.2139/ssrn.2196059

Richard Kopcke (Contact Author)

Boston College - Center for Retirement Research ( email )

Fulton Hall 550
Chestnut Hill, MA 02467
United States

Anthony Webb

Boston College - Center for Retirement Research ( email )

Fulton Hall 550
Chestnut Hill, MA 02467
United States

Joshua Hurwitz

Boston College - Center for Retirement Research ( email )

Boston, MA
United States

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