Optimal portfolio and consumption choices of retirees with uncertain lifetimes under cumulative prospect theory

Liurui Deng, Zilan Liu and Jie Tan

Applied Economics, 2022, vol. 54, issue 49, 5690-5716

Abstract: In this paper, based on Cumulative Prospect Theory (CPT), we focus on the optimal portfolio and consumption under uncertain lifetime. Previous work considers similar problems under Expected Utility Theory but not CPT. Our main contribution is to use CPT to more accurately model the characteristics of the retirees’ psychology and investment behavior after retirement. Moreover, we study the effect of the changes in psychology related to investment on consumption over an uncertain lifetime. We obtain explicit solutions for the optimal portfolio and consumption decisions. Furthermore, through numerical analysis, we compare our optimal consumption with that obtained by Alexander Kremer et al. In empirical analysis, we obtain the result that there is a significant inverted U-shaped relationship between the retirement age and the consumption rate. The result is consistent with one of theoretical and numerical analysis. Endogenous test and robustness test also support this result. Furthermore, we achieve the key conclusion that the effect of retirement age on consumption rate is heterogeneous. Specially, the impact of retirement age on consumption is different for different medical costs, geographic areas, gender and levels of education. But, the inverted U-shaped relationship between the retirement age and the consumption rate still exists.

Date: 2022
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DOI: 10.1080/00036846.2022.2048788

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