The Effect of Objective Formulation on Retirement Decision Making

Posted: 8 Oct 2015

See all articles by Adam Butt

Adam Butt

Australian National University - Research School of Finance, Actuarial Studies & Statistics

Gaurav Khemka

Australian National University (ANU)

Date Written: 2015

Abstract

For a retiree who must maintain both investment and longevity risks, we consider the impact on decision making of focusing on an objective relating to the terminal wealth at retirement, instead of a more correct objective relating to a retirement income. Both a shortfall and a utility objective are considered; we argue that shortfall objectives may be inappropriate due to distortion in results with non-monotonically correlated economic factors. The modelling undertaken uses a dynamic programming approach in conjunction with Monte-Carlo simulations of future experience of an individual to make optimal choices. We find that the type of objective targeted can have a significant impact on the optimal choices made, with optimal equity allocations being up to 30% higher and contribution amounts also being significantly higher under a retirement income objective as compared to a terminal wealth objective. The result of these differences can have a significant impact on retirement outcomes.

Keywords: Bootstrap Method, Simulation, Dynamic Programming, Optimization, Retirement

JEL Classification: C150, C610, D140

Suggested Citation

Butt, Adam and Khemka, Gaurav, The Effect of Objective Formulation on Retirement Decision Making (2015). Insurance: Mathematics and Economics, Vol. 64, 385-395, Available at SSRN: https://ssrn.com/abstract=2670408

Adam Butt (Contact Author)

Australian National University - Research School of Finance, Actuarial Studies & Statistics ( email )

Canberra, Australian Capital Territory 2601
Australia

Gaurav Khemka

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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