MPC Heterogeneity and Household Balance Sheets

We use sizable lottery prizes in Norwegian administrative panel data to explore how transitory income shocks are spent and saved over time and how households’ marginal propensities to consume (MPCs) vary with household characteristics and shock size. We find that spending peaks in the year of winning and gradually reverts to normal within five years. Controlling for all items on households’ balance sheets and characteristics such as education and income, it is the amount won, age, and liquid assets that vary systematically with MPCs. Low-liquidity winners of the smallest prizes (around US$1,500) are estimated to spend all within the year of winning. The corresponding estimate for high-liquidity winners of large prizes (US$8, 300–150,000) is slightly below one-half. While conventional models will struggle to account for such high MPC levels, we show that a two-asset life cycle model with a realistic earnings profile and a luxury bequest motive can account for both the time profile of consumption responses and their systematic covariation with observables. (JEL D12, D15, E21, G51, H24)

Optimal portfolio choice with tontines under systematic longevity risk

We derive optimal portfolio choice patterns in retirement (ages 66–105) for a constant relative risk aversion utility maximising investor facing risky capital market returns, stochastic mortality risk, and income-reducing health shocks. Beyond the usual stocks and bonds, the individual can invest his assets in tontines. Tontines are cost-efficient financial contracts providing age-increasing, but volatile cash flows, generated through the pooling of mortality without guarantees, which can help to match increasing financing needs at old ages. We find that a tontine invested in the risk-free asset dominates stock investments for older investors without a bequest motive. However, with a bequest motive, it is optimal to replace the tontine investment over time with traditional financial assets. Our results indicate that early in retirement, a tontine is only an attractive investment option, if the tontine funds are invested in a risky asset. In this case, they crowd out stocks and risk-free bonds in the optimal portfolios of younger investors. Over time, the average optimal portfolio weight of tontines decreases. Introducing systematic mortality risks noticeably reduces the peak allocation to tontines.