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LIFE INSURANCE AND PENSION CONTRACTS II: THE LIFE CYCLE MODEL WITH RECURSIVE UTILITY

Published online by Cambridge University Press:  11 November 2015

Knut K. Aase
Knut K. Aase*
Affiliation:
Department of Business and Management Science, The Norwegian School of Economics, 5045 Bergen, Norway
*
E-Mail: [email protected]
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Abstract

We analyze optimal consumption and pension insurance during the life time of a consumer using the life cycle model, when the consumer has recursive utility. The relationship between substitution of consumption and risk aversion is highlighted, and clarified by the introduction of this type of preferences. We illustrate how recursive utility can be used to explain the empirical consumption puzzle for aggregates. This indicates a plausible choice for the parameters of the utility function, relevant for the consumer in the life cycle model. Optimal life insurance is considered, as well as the portfolio choice problem related to optimal exposures in risky securities. A major finding is that it is optimal for the typical insurance buyer to smooth adverse shocks to the financial market, unlike what is implied by the conventional model. This has implications for what type of contracts the life and pension insurance industry should offer.

Keywords

Optimal pension insuranceoptimal life insurancerecursive utilitydefined benefitdefined contributionconsumption puzzleinvestment problem
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 46 , Issue 1 , January 2016 , pp. 71 - 102
Copyright
Copyright © Astin Bulletin 2015 

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