Optimal Annuitization with Stochastic Mortality Probabilities

47 Pages Posted: 13 Jul 2013

See all articles by Felix Reichling

Felix Reichling

Penn Wharton Budget Model

Felix Reichling

Government of the United States of America - Macroeconomic Analysis Division

Kent A. Smetters

University of Pennsylvania - Business & Public Policy Department; National Bureau of Economic Research (NBER)

Date Written: July 2013

Abstract

The conventional wisdom dating back to Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Numerous market frictions do not break this sharp result. We modify the Yaari framework by allowing a household's mortality risk itself to be stochastic. Annuities still help to hedge longevity risk, but they are now subject to valuation risk. Valuation risk is a powerful gateway mechanism for numerous frictions to reduce annuity demand, even without ad hoc "liquidity constraints." We find that most households should not annuitize any wealth. The optimal level of aggregate net annuity holdings is likely even negative.

Suggested Citation

Reichling, Felix and Reichling, Felix and Smetters, Kent, Optimal Annuitization with Stochastic Mortality Probabilities (July 2013). NBER Working Paper No. w19211, Available at SSRN: https://ssrn.com/abstract=2293283

Felix Reichling (Contact Author)

Penn Wharton Budget Model ( email )

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Felix Reichling

Government of the United States of America - Macroeconomic Analysis Division ( email )

Kent Smetters

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

National Bureau of Economic Research (NBER)

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