Social Science
Welfare costs of suboptimal retiree decisions
author list,
Peer Reviewed
Abstract
We make a novel investigation of welfare costs associated with various suboptimal decisions made by retirees, both analytically and numerically. We utilize a unique framework that incorporates recursive utility with housing, and also encompasses expected utility and recursive utility without housing as special cases. Our findings indicate that under-investment in stocks incurs lower welfare costs compared to an equivalent over-investment. Suboptimal allocations in bond holdings result in higher costs than similar misallocations in stocks. Choosing not to participate in the stock market is less detrimental than avoiding the bond market. Should retirees opt to simplify their decision-making by investing solely in one type of asset, it is less costly for them to invest exclusively in bonds. Overconsumption of housing is less costly than an equivalent underconsumption. Suboptimal consumption imposes the highest welfare cost. Decisions regarding consumption, housing, and savings are found to be more crucial than the choice of how to distribute liquid savings between stocks and bonds. Additionally, recursive utility model better captures retirees’ preference for bonds over stocks than expected utility model. Our results, which are consistent across various parameter settings, provide valuable insights for academics and policymakers aiming to enhance retiree welfare.
Key Questions
1. What is the purpose of the study?
The study aims to assess the welfare costs associated with various suboptimal decisions made by retirees, utilizing a unique framework that incorporates recursive utility with housing.
2. What are the main findings regarding investment decisions?
The study finds that under-investment in stocks incurs lower welfare costs compared to an equivalent over-investment.
3. How do bond holdings affect welfare costs?
Suboptimal allocations in bond holdings result in higher costs than similar misallocations in stocks.
4. What is the impact of choosing not to participate in the stock or bond markets?
Choosing not to participate in the stock market is less detrimental than avoiding the bond market.
5. How does overconsumption of housing compare to underconsumption?
Overconsumption of housing is less costly than an equivalent underconsumption.
6. What is the most costly suboptimal decision?
Suboptimal consumption imposes the highest welfare cost.
7. How do decisions regarding consumption, housing, and savings compare to asset allocation?
Decisions regarding consumption, housing, and savings are found to be more crucial than the choice of how to distribute liquid savings between stocks and bonds.
8. Which utility model better captures retirees' preferences?
The recursive utility model better captures retirees’ preference for bonds over stocks than the expected utility model.
Summary
Aydilek and Aydilek's study investigates the welfare costs associated with various suboptimal decisions made by retirees, utilizing a unique framework that incorporates recursive utility with housing. The findings indicate that under-investment in stocks incurs lower welfare costs compared to an equivalent over-investment. Suboptimal allocations in bond holdings result in higher costs than similar misallocations in stocks. Choosing not to participate in the stock market is less detrimental than avoiding the bond market. Overconsumption of housing is less costly than an equivalent underconsumption. Suboptimal consumption imposes the highest welfare cost. Decisions regarding consumption, housing, and savings are found to be more crucial than the choice of how to distribute liquid savings between stocks and bonds. Additionally, the recursive utility model better captures retirees’ preference for bonds over stocks than the expected utility model. These insights provide valuable information for academics and policymakers aiming to enhance retiree welfare.
