Personal Life-Cycle Financial Planning Decision Model

This paper derives the optimal consumption and portfolio choice pattern over the life-cycle for households facing uninsurable labor income risk, ruin risk, stochastic capital markets, and uncertain lifetime. Our model posits a dynamic utility maximized with CRRA and Epstein-Zin preferences that has access to liquid stocks, bonds, and illiquid life annuities. The empirical results of this research indicate that the annuity insurance commodity can hedge longevity risk. The investor would purchase the annuity insurance commodity, enhancing her own level of utility.

I. Introduction

Many financial economists are interested in the problem of portfolio optimization. Analytical solutions for optimal portfolio choice problems are often available in single period models. However, in a multi-period model, the portfolio optimization problem is complicated because it is inherently nonlinear. Therefore, this research proposes employing a personal life-cycle financial planning model based on financial theory in order to help the variety of investors make a comprehensive personal financial planning decision. But studying household financial problems in long-term portfolio choice models is challenging because it requires considering stochastic investment opportunity sets, illiquid assets such as labor income, housing or deferred tax accounts, and mortality risk [1].