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Cagri Kumru and Athanasios C. Thanopoulos
September 2011

This paper examines the impact of various fiscal policies, namely, taxes on consumption, labor and capital when agents have self-control preferences. Agents trade in a stochastic overlapping generations economy while facing borrowing constraints. We quantitatively show that modelling choices, such as, liquidity constraints, life-cycle structure and idiosyncratic earnings risks, that were previously considered to be critical in delivering a positive capital income tax, need not be binding in this regard. We argue and quantitatively show that for a sufficiently large measure of individuals having self-control preferences instead of CRRA preferences, or alternatively, for a sufficiently high cost of exercising self control when all individuals are self-control types, the optimal capital income tax is zero. Given there is strong empirical and experimental evidence regarding the existence of self-control problems, our model provides quite an interesting insight: as agents' self-control costs rise, the optimal capital income tax rate will converge to Chamley and Judd value.

 
Hazel Bateman, Christine Ebling, John Geweke, Jordan Louviere, Stephen Satchell, Susan Thorp
May 2011

This research studies the propensity of individuals to violate implications of expected utility maximization in allocating retirement savings within a compulsory defined contribution retirement plan. The paper develops the implications and describes the construction and administration of a discrete choice experiment to almost 1200 members of Australia's mandatory retirement savings scheme. The experiment finds overall rates of violation of roughly 25%, and substantial variation in rates, depending on the presentation of investment risk and the characteristics of the participants. Presentations based on frequency of returns below or above a threshold generate more violations than do presentations based on the probability of returns below or above thresholds. Individuals with low numeracy skills, assessed as part of the experiment, are several times more likely to violate implications of the conventional expected utility model than those with high numeracy skills. Older individuals are substantially less likely to violate these restrictions, when risk is presented in terms of event frequency, than are younger individuals. The results pose significant questions for public policy, in particular compulsory defined contribution retirement schemes, where the future welfare of participants in these schemes depends on quantitative decision-making skills that a significant number of them do not possess.

 
Hazel Bateman, Christine Eckert, John Geweke, Jordan Louviere, Stephen Satchell and Susan Thorp
2011

Financial regulators are weighing up the effectiveness of different templates for communicating investment risk to retirement savers since welfare depends on comprehension of risk information. We compare nine standard risk presentations using a discrete choice experiment where subjects choose between three retirement accounts. Switching between graphical or textual presentations, or between formats that emphasize benchmarks rather than return ranges or values at risk, affects predicted choices more than large changes in underlying risk. Innumerate individuals are more susceptible to presentation, and those with weak basic financial literacy are insensitive to increasing risk levels, regardless of presentation. Presentation effects are moderated but not eliminated as financial literacy improves.

 
Michael Keane and Olena Stavrunova
November 2011

The size of adverse selection and moral hazard effects in health insurance markets has important policy implications. For example, if adverse selection effects are small while moral hazard effects are large, conventional remedies for inefficiencies created by adverse selection (e.g., mandatory insurance enrolment) may lead to substantial increases in health care spending. Unfortunately, there is no consensus on the magnitudes of adverse selection vs. moral hazard. This paper sheds new light on this important topic by studying the US Medigap (supplemental) health insurance market.

 
Katja Hanewald and Michael Sherris
November 2011

The recent international credit crisis has highlighted the significant exposure that banks and insurers, especially mono-line credit insurers, have to residential house price risk. This paper provides an assessment of risk models for residential property for applications in banking and insurance including pricing, risk management, and portfolio management. Risk factors and heterogeneity of house price returns are assessed at a postcode-level for house prices in the major capital city of Sydney, Australia, over the period 1979 to 2011.

 
Michael Keane
June 2011

This paper examines the effect of labor income taxation in life-cycle models where work experience builds human capital. In this case, the wage no longer equals the opportunity cost of time - which is, instead, the wage plus returns to work experience. This has a number of interesting consequences. First, contrary to conventional wisdom, in such a model permanent tax changes can have larger effects on labor supply than temporary tax changes. Second, even with small returns to work experience, conventional methods of estimating the inter-temporal elasticity of substitution will be very seriously biased towards zero. Third, for plausible parameter values, both compensated and uncompensated labor supply elasticities are likely to be quite a bit larger than (conventional) estimates of the inter-temporal elasticity of substitution (despite the fact that the latter is typically viewed as an upper bound on the former). Fourth, for plausible parameter values, large welfare losses from proportional income taxation are quite consistent with existing (small) estimates of labor supply elasticities.

 
Katja Hanewald, John Piggott and Michael Sherris
August 2011

This paper analyzes an individual's post retirement longevity risk management strategy allowing for systematic longevity risk, recent product innovations, and product loadings. A complete-markets discrete state model and multi-period simulations of portfolio strategies are used to assess individual longevity insurance product portfolios with differing levels of systematic and idiosyncratic longevity risk. Portfolios include: fixed life annuities, deferred annuities, inflation-indexed annuities, phased withdrawals and recently proposed group self-annuitization (GSA) plans.

 
Renuka Sane and John Piggott
2011

Many countries have policies offering transfers or other entitlements, subject to a resources test. In most cases, these exempt the family home. While the impacts of means-tested programs on saving and labor supply have been extensively studied, exempting the owner-occupier home has escaped analytic attention. We assess the exemption of the owner-occupied home from the Australian age-pension on residential mobility and housing trade-downs. Results suggest that this provision discourages trade-down behaviour.

 
Thomas Post and Katja Hanewald
August 2011

Abstract Theoretical studies suggest that unexpected changes in future survival probabilities, that is, longevity risk, are important determinants of individuals' decision making about consumption, saving, allocation of assets, and retirement timing. Based on a data set that matches subjective survival expectations and savings indicators from the Survey of Health, Ageing and Retirement in Europe (SHARE) with life table data from the Human Mortality Database this study provides first empirical evidence that individuals are aware of longevity risk.

 
Chung Tran and Alan Woodland
August 2011

This paper proposes and assesses consistent multi-factor dynamic ane mortality models for longevity risk applications. The dynamics of the model produce closed-form expressions for survival curves. The framework includes an arbitrage free model specication. Importantly, the mortality model provides consistent future survival curves with the same parametric form as the initial curve.

 
Hazel Bateman and John Piggott
July 2011

This paper documents developments in public sector pensions in Australia, and reports estimated unfunded liabilities associated with benefits promised to public sector employees. Australia's experience with public sector pensions is unusual - currently, the defence forces and the judiciary apart, all new entrants to public sector schemes confront defined contribution (DC) plans. The transition from defined benefit (DB) to DC has taken place over the last 20 years.

 
Craig Blackburn, Michael Sherris
May 2011

This paper proposes and assesses consistent multi-factor dynamic affine mortality models for longevity risk applications. The dynamics of the model produce closed-form expressions for survival curves. The framework includes an arbitrage-free model specification. There are multiple risk factors allowing applications to hedging and pricing mortality and longevity bonds, mortality derivatives and more general risk management problems. A state-space representation is used to estimate parameters for the model with the Kalman filter. A 3-factor model specification is shown to provide a good fit to the observed survival curves especially for older ages, and performs better than the 2-factor models. Consistent models are shown to improve model performance and stability.

 
Carolyn Njenga and Michael Sherris
March 2011

Mortality risk models have been developed to capture trends and common factors driving mortality improvement. Multiple factor models take many forms and are often developed and fitted to older ages. In order to capture trends from young ages it is necessary to take into account the richer age structure of mortality improvement from young ages to middle and then into older ages.

 
Chao Qiao and Michael Sherris
March 2011

Group Self-annuitisation Schemes (GSAs), or Pooled Annuity Schemes, are designed to share uncertain future mortality experience including systematic improvements. They have been proposed because of the significant uncertainty of future mortality improvement on pension and annuity costs. The challenges for designing group pooled schemes include the decreasing average payments when mortality improves significantly, the decreasing numbers in the pool at the older ages and the dependence of systematic mortality improvements across different ages of members in the pool.

 
Shu Su and Michael Sherris
March 2011

Heterogeneity in mortality rates is known to exist in populations, undermining the use of age and sex as the only rating factors for life insurance and annuity products. Life insurers underwrite life products using a variety of rating factors to
allow for this heterogeneity. In the case of life annuities, there is limited underwriting used. Life insurers rely on an assumption that lives will self select and price the longevity risk with an annuity mortality table that assumes above average longevity.

 
Juergen Jung and Chung Tran
Februaru 2011

In this paper we develop a stochastic dynamic general equilibrium overlapping gener ations (OLG) model with endogenous health capital to study the macroeconomic effects of the Affordable Care Act of March 2010 also known as the Obama health care reform. We find that the insurance mandate enforced with fines and premium subsidies successfully reduces adverse selection in private health insurance markets and subsequently leads to almost universal coverage of the working age population.

 
Erik Hernaes, John Piggott, Ola Lotherington Vestad and Tao Zhang
March 2011

This paper revisits the question of whether defined benefit pension plans inhibit labour mobility. Using national register data for three distinct periods, we define and calculate a measure of changes in individual pension entitlements which we term potential portability gain. Estimation results indicate that the effect of portability gains on the propensity to change jobs is either weak or non-existent, and there are no signs of gains or losses in pension entitlements being reflected in wages for job changes.