Working Paper: NBER ID: w19168
Authors: Jeffrey R. Brown; Arie Kapteyn; Erzo FP Luttmer; Olivia S. Mitchell
Abstract: We show that people have difficulty valuing annuities, and this, instead of a preference for lumpsums, helps explain observed low annuity demand. Although the median price at which people are willing to sell an annuity stream is close to the actuarial value, many responses diverge greatly from optimizing behavior. Moreover, people will pay substantially less to buy than to sell annuities. We conclude that boundedly rational consumers adopt "buy low, sell high" heuristics when confronting a complex trade-off. This suggests that many consumers do not make optimizing decisions, underscoring the difficulty of explaining cross-sectional annuity valuation differences using standard models.
Keywords: annuities; cognitive constraints; financial literacy
JEL Codes: D03; G02; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Cognitive limitations (D91) | Difficulty valuing annuities (G19) |
| Difficulty valuing annuities (G19) | Divergence between buy and sell prices (G19) |
| Cognitive limitations (D91) | Divergence between buy and sell prices (G19) |
| Lower cognitive ability (D91) | Less consistent valuation behavior (G40) |
| Buy valuations (D46) | Sell valuations (G19) |
| Cognitive ability (G53) | Buy-sell valuation discrepancy (G32) |