A behavioural finance perspective on retirement guarantees

  • Andreea Victoria Popescu Andreea Victoria Popescu

The current paper derives a mathematical model of a pension insurance contract which simultaneously provides an escalating guarantee for retirement income and allows for a life cycle asset allocation style of investing. With the help of simulations we are able to measure the difference in welfare between life cycle strategies that contain different levels of guarantees and a life cycle strategy without
guarantees. In an expected utility framework we observe that guarantees generate a loss in utility although the loss is negligible. Furthermore, the paper found that the demand for an escalating guarantee may be explained by the inclusion of agent’s behavioral characteristics. More specifically, the incorporation of
cumulative prospect theory enables the combination of guarantees and life cycle investment strategies to be welfare improving. This result holds irrespective of the level of guarantee. The superiority of the
insurance strategy seems to be dependent on the behavioral trait of subjective probability weighting.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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