Dynamic Asset Allocation When Bequests are Luxury Goods
16 Pages Posted: 24 May 2014
Date Written: May 20, 2013
Luxury bequests impart systematic effects of age to an investor's optimal allocation: the expected percentage allocation to equities rises throughout retirement. When bequests are luxuries the marginal utility of bequests declines more slowly than the marginal utility of consumption. This is essentially lower risk aversion. As a retiree approaches death, her expected remaining lifetime utility is increasingly composed of bequest utility, and thus generates progressively lower risk aversion. A retiree responds by increasingly favoring the higher-return risky asset. Compared to standard preferences, luxury bequests elevate a retiree's average exposure to risky assets, but the difference is small in early retirement.
Keywords: bequests, luxury goods, dynamic asset allocation, Merton portfolio problem, European put option, retirement risk zone
JEL Classification: D14, G11, G23
Suggested Citation: Suggested Citation