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The effect of objective formulation on retirement decision making

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  • Butt, Adam
  • Khemka, Gaurav

Abstract

For a retiree who must maintain both investment and longevity risks, we consider the impact on decision making of focusing on an objective relating to the terminal wealth at retirement, instead of a more correct objective relating to a retirement income. Both a shortfall and a utility objective are considered; we argue that shortfall objectives may be inappropriate due to distortion in results with non-monotonically correlated economic factors. The modelling undertaken uses a dynamic programming approach in conjunction with Monte-Carlo simulations of future experience of an individual to make optimal choices. We find that the type of objective targetted can have a significant impact on the optimal choices made, with optimal equity allocations being up to 30% higher and contribution amounts also being significantly higher under a retirement income objective as compared to a terminal wealth objective. The result of these differences can have a significant impact on retirement outcomes.

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  • Butt, Adam & Khemka, Gaurav, 2015. "The effect of objective formulation on retirement decision making," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 385-395.
    • Handle: RePEc:eee:insuma:v:64:y:2015:i:c:p:385-395
    DOI: 10.1016/j.insmatheco.2015.07.004
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    Cited by:

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    2. Minney, Aaron & Zhu, Zili & Guo, Ying & Li, Jiaming & Toscas, Peter & Koo, Bonsoo & Pantelous, Athanasios A., 2022. "Using the pension multiple to measure retirement outcomes," Finance Research Letters, Elsevier, vol. 49(C).
    3. Gaurav Khemka & Yifu Tang & Geoffrey J. Warren, 2021. "The ‘right’ level for the superannuation guarantee: identifying the key considerations," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(3), pages 4435-4474, September.
    4. Geoffrey J Warren, 2022. "Design of comprehensive income products for retirement using utility functions," Australian Journal of Management, Australian School of Business, vol. 47(1), pages 105-134, February.
    5. Gaurav Khemka & Adam Butt, 2017. "Non-Parametric Integral Estimation Using Data Clustering in Stochastic dynamic Programming: An Introduction Using Lifetime Financial Modelling," Risks, MDPI, vol. 5(4), pages 1-17, October.
    6. Koo, Bonsoo & Pantelous, Athanasios A. & Wang, Yunxiao, 2022. "Novel utility-based life cycle models to optimise income in retirement," European Journal of Operational Research, Elsevier, vol. 299(1), pages 346-361.

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    More about this item

    Keywords

    Bootstrap method; Simulation; Dynamic programming; Optimisation; Retirement;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance

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