Optimal consumption and portfolio choice of retirees with longevity risk

• Published in: Journal of pension economics & finance Vol. 13; no. 3; pp. 227 - 249
• Main Authors: KREMER, ALEXANDER, LIESE, FRIEDRICH, HOMÖLLE, SUSANNE, CLAUSEN, JOHANN
• Format: Journal Article
• Language: English
• Published: Cambridge, UK Cambridge University Press 01.07.2014
• Subjects: G11 (JEL); asset allocation; mortality; retirement period; life time distribution
• ISSN: 1474-7472; 1475-3022
• DOI: 10.1017/S1474747213000280

The question how to optimize consumption and portfolio choice over the life cycle has been widely discussed in the literature so far. In this paper we concentrate on a retiree's optimal consumption and portfolio selection over his remaining years of life. We apply the logistic model of mortality thus modeling the empirically observed increase of mortality during the retirement period. The optimal consumption strategy and portfolio choice are established by reducing the Hamilton-Jacobi-Bellmann equation to the explicit solution of an ordinary differential function (ODF) that includes the mortality rate. A general finding is that the Merton-Samuelson result of constant portfolio choice for a constant mortality is confirmed for arbitrary mortality. The portfolio choice is only influenced by risk and return of assets and the retirees’ risk aversion. To get the specific optimal consumption strategy in a realistic situation the logistic model of mortality has been fitted to the data of the Statistical Yearbook for the Federal Republic of Germany 2006/2008. The optimal initial value for the ODF is obtained by numerical methods. The solution provides a large increase in the ratio of optimal consumption to wealth up to about 92 years followed by a sharp decrease. A bequest motive dampens the magnitudes of the ups and downs of the consumption ratio but does not change the basic shape.