Liquidity constraints and optimal annuitization

In this paper, we view an individual's annuitization decision as an American style call option whose underlying asset is financial wealth, which controls the distance to annuitization. We then derive a certain threshold of wealth over which the individual is optimal to annuitize all of her weal...

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Bibliographic Details
Published in:Seonmul yeongu (Online) 2022-04, Vol.30 (2), p.125-142
Main Author: Park, Seyoung
Format: Article
Language:English
Subjects:
Annuitization
Borrowing
Brownian motion
Consumption
Coronaviruses
COVID-19
Derivatives
Interest rates
Investment
Investments
Leisure
Liquidity constraints
Pandemics
Retirement
Securities markets
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Summary:In this paper, we view an individual's annuitization decision as an American style call option whose underlying asset is financial wealth, which controls the distance to annuitization. We then derive a certain threshold of wealth over which the individual is optimal to annuitize all of her wealth. We particularly focus on the effects of liquidity constraints on the individual's optimal annuitization decision, concerning their effects on the optimal investment and consumption strategies. We show that the annuitization decision can be significantly affected by the extent to which individual borrowing is constrained. More specifically, the optimal decision is for the individual to annuitize earlier with the tighter liquidity constrains she is exposed to than initially planned. This is particularly relevant to today's pandemic situation especially with the growing concern about cutting credit limits.
ISSN:1229-988X
2713-6647
DOI:10.1108/JDQS-12-2021-0033