Working Paper: NBER ID: w19211
Authors: Felix Reichling; Kent Smetters
Abstract: The conventional wisdom dating back to Yaari (1965) is that households without a bequest motive should fully annuitize their investments. Numerous market frictions do not break this sharp result. We modify the Yaari framework by allowing a household's mortality risk itself to be stochastic. Annuities still help to hedge longevity risk, but they are now subject to valuation risk. Valuation risk is a powerful gateway mechanism for numerous frictions to reduce annuity demand, even without ad hoc "liquidity constraints." We find that most households should not annuitize any wealth. The optimal level of aggregate net annuity holdings is likely even negative.
Keywords: Annuities; Stochastic Mortality; Valuation Risk; Health Shocks
JEL Codes: D01; D14; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stochastic mortality probabilities (C41) | optimal level of annuitization (G52) |
| valuation risk (G32) | value of annuities (G12) |
| negative health shocks (I12) | attractiveness of annuities (D15) |
| negative health shocks (I12) | optimal level of annuitization (G52) |
| lower patience (C69) | likelihood to annuitize (G52) |