How Does Consumption Habit Affect the Household's Demand for Life-Contingent Claims?

45 Pages Posted: 31 Jul 2018

See all articles by Ken Seng Tan

Ken Seng Tan

University of Waterloo

Pengyu Wei

Nanyang Technological University (NTU); University of Waterloo - Department of Statistics and Actuarial Science

Sheng Chao Zhuang

University of Nebraska Lincoln

Date Written: July 10, 2018

Abstract

This paper examines the impact of habit formation on demand for life-contingent claims in a life-cycle model. We solve the optimal consumption, portfolio choice, and life insurance/annuity problem analytically, and illustrate the mechanism how consumption habit can alter the bequest motive and therefore drive the demand for life-contingent products. We show that habit formation alone can partially address the mismatch in the life insurance market between the life insurance holdings of most households and their underlying financial vulnerabilities, or the mismatch in the annuity market between the lack of any annuitization and the risk of outliving their financial wealth, but not both. However, habit formation together with social security may shed some light on the puzzling thinness of both life insurance and voluntary annuity market.

Suggested Citation

Tan, Ken Seng and Wei, Pengyu and Zhuang, Sheng Chao, How Does Consumption Habit Affect the Household's Demand for Life-Contingent Claims? (July 10, 2018). Available at SSRN: https://ssrn.com/abstract=3211009 or http://dx.doi.org/10.2139/ssrn.3211009

Ken Seng Tan

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Pengyu Wei (Contact Author)

Nanyang Technological University (NTU) ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

University of Waterloo - Department of Statistics and Actuarial Science ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada

Sheng Chao Zhuang

University of Nebraska Lincoln ( email )

730 N. 14th Street
Lincoln, NE 68588
United States
4024722330 (Phone)

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