Risk perception and framing of financial decisions during the payout phase of retirement

• Applicant: Professor Dr. Sven Nolte
• Subject Area: Accounting and Finance
• Term: from 2017 to 2019
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 364999955

Retirement savings decisions are among the most important decisions of private households due to their severe financial consequences. In recent years, responsibility for retirement savings has been shifted from public pension systems towards those households. The complexity of decisions in the context of retirement provisions presents many people with problems, so that behavioral research has gained importance in this field. Most of this research deals with the savings phase. Much less studied, albeit more and more relevant considering ageing populations, is the payout phase, i.e., the time after the working life. Here, households also face difficult decisions but have to deal with additional, unfamiliar risk types. The focus of this research project are two specific risk types: inflation risk and longevity risk. Inflation risk is particularly relevant during the payout phase, as there is no human capital left to counteract the devaluation of money. Longevity risk describes the risk of living so long that the saved capital is used up and there is no available income left. Although annuities provide an effective insurance against this risk, they are purchased much less often than standard economic theory would predict. Recent research suggests that this phenomenon – known as annuity puzzle – has a behavioral explanation based on the specific framing of the decision situation. Households do not perceive annuities as insurance products, but rather as a gamble on the length of one’s own life. An annuity would then not reduce but add risk, namely the risk of getting back less than the invested capital. In this context, ambiguity aversion and loss aversion play an important role. Both phenomena have been investigated thoroughly in the judgement and decision making literature, but not much is known about what their effect is in the specific dynamic setting of the payout phase. Here, ambiguity does not concern the uncertainty regarding the size of returns, but instead the uncertainty regarding longevity and thus the time length of payments. The goal of this research project is to uncover, understand, and explain systematic biases and mistakes in decision making during the payout phase of retirement by means of behavioral and experimental research. Ambiguity aversion and loss aversion in the context of framing are the focus of the analyses. For this purpose, annuities as well as specific product characteristics and features like inflation protection and nominal capital guarantees are investigated.

• DFG Programme: Research Fellowships
• International Connection: USA
• Host: Professor Colin F. Camerer, Ph.D.