How Does Consumption Habit Affect the Household's Demand for Life-Contingent Claims?
45 Pages Posted: 31 Jul 2018
Date Written: July 10, 2018
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.
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