Life-Cycle Asset Allocation with Annuity Markets: Is Longevity Insurance a Good Deal?

Wolfram Horneff, Raimond Maurer and Michael Stamos
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Wolfram Horneff: Johann Wolfgang Goethe-University of Frankfort
Raimond Maurer: Johann Wolfgang Goethe-University of Frankfort
Michael Stamos: Johann Wolfgang Goethe-University of Frankfort

Working Papers from University of Michigan, Michigan Retirement Research Center

Abstract: We derive the optimal portfolio choice over the life-cycle for households facing labor income, capital market, and mortality risk. In addition to stocks and bonds, households also have access to incomplete annuity markets offering a hedge against mortality risk. We show that a considerable fraction of wealth should be annuitized to skim the return enhancing mortality credit. The remaining liquid wealth (stocks and bonds) is used to hedge labor income risk during work life, to earn the equity premium, and to ensure estate for the heirs. Furthermore, we assess the importance of common explanations for limited participation in annuity markets.

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Date: Written 2006-12
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