Speakers: Javier Garcia Gonzalez and Henk Keffert, Tilburg University
Title Javier: Lifecycle investing using housing to attain labor income exposure
Abstract: I study the possibilities that residential real estate investment brings to lifecycle portfolios. My model provides a framework to analyze the potential contributions of this asset class to pension fund portfolios. Moreover, it can rationalize the traditional role of housing, and not stocks, as the primary savings vehicle of households. Labor income is at the core of lifecycle models and house prices have been linked to average income through rents in the literature. On top of consuming housing services, people also consume many labor-intensive services with a cost that is closely related to the average labor income in their region, such as elderly care, health care or education. What makes investment in residential real estate attractive is thus the potential to hedge both housing and labor intensive services by exposing the portfolio to income changes.
Title Henk: Habit formation, income asymmetry, and the optimal design of partner pensions
Abstract: Partner pensions, the benefits paid to a surviving spouse after their partner’s death, play a crucial but often overlooked role in retirement planning for couples. Drops in disposable income can lead to substantial welfare losses, especially when one partner is financially dependent on the other. We develop a rich life-cycle investing model that incorporates habit formation and calibrate it using data on retired Dutch couples to analyse partner pension design. We find a trade-off in partner pension: couples with highly asymmetric income benefit from a larger partner pension, while for more symmetric couples it is optimal to have a lower partner pension. The ability to purchase life insurance at older ages is especially important for asymmetric couples to reduce welfare losses if there is insufficient partner pension. In the Netherlands, it is common practice to pay 70% of the deceased’s pension income to the survivor. Even in the most asymmetric cases, a 70% partner pension typically leads to an increase in consumption after the death of the breadwinner, suggesting that the 70% is rather high.
Important factors that influence the optimal partner pension for a couple are their preferences and the economic benefits of being in a couple. The more economical it is to be in a couple, the larger the partner pension should be to compensate not only for lower income but also the loss of the economies of scale benefit. The more risk averse the couple is or the stronger their degree of habit formation, the larger their aversion is to consumption drops and the larger the partner pension should be. Many European countries use a one-size-fits-all approach, which may seem restrictive. However, even in the most extreme scenarios we consider, the optimal one-size-fits-all solution only leads to a welfare loss of about 2%.
Joint work with: Anja De Waegenaere and Nikolaus Schweizer