Optimal Annuitization Strategy with a Large, Negative Economic Shock

Annuitization theory must reflect the fact that, in reality, annuity income is no longer certain, rather it is uncertain because of increased concern about a large, negative economic shock (LNES), thereby resulting in annuity income insecurity and volatility. We take this reality into account the annuitization model by allowing the annuity income to plummet immediately after the occurrence of the LNES driven by a Poisson jump process. We derive a certain threshold of wealth-to-income ratio and find that whenever the ratio exceeds its threshold, it is optimal for the retiree to escalate annuities by the amount where the ratio falls and gets close to the threshold. Finally, we shed some new light on the retiree’s optimal consumption/savings and portfolio choice with the LNES.