Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses
Optimizing the Equity-Bond-Annuity Portfolio in Retirement: The Impact of Uncertain Health Expenses
This chapter offers a comprehensive stochastic life-cycle framework to address the major risks and choices for households in the retirement phase. It assumeds, for purposes of discussion, that annuitization can be made at any age and in any amount, in contrast to a one-time choice of annuitization upon retirement in many previous studies. Life annuity basically represents a class of financial assets with its own unique risk and return features. The key logic in the chapter is that the uncertainty in uninsured health expenses generally leads to precautionary savings, and rational households should shift their assets from risky equities to riskless bonds for a desired level of risk exposure. The simulated optimal portfolio is similar to the practice of life-cycle (target-date) funds in the retirement phase.
Keywords: retirement phase, annuitization, life annuity, financial assets, risk and return, precautionary savings, risky equities, riskless bonds, risk exposure
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