The Impact of Individual Investment Behavior for Retirement Welfare: Evidence from the United States and Germany

6 Welfare Analyses

In this section, we analyze the welfare consequences for the individuals in the SCF
and EVS data sets that result from choosing different asset allocations than proposed
by the normative model.

We utilize an equivalent wealth variation measure as, for example, in Brown (2001).
The optimal expected utility as given by the value function¹⁸ for t = 0 from the
benchmark model V0^*(W0, L0) is compared with the expected utility resulting from
actual behavior V0^act(W0, L0). For each individual, equation (7) is solved for ∆W0 and
then divided by W0 to obtain a relative measure.

V0^*(W0, L0) = V0^act(W0 + ∆W0, L0).                          (7)

The relative measure ∆W0 / W0 has the advantage of enabling comparisons of U.S.
and German individuals without having to consider differences in the purchasing
power of dollars and euros and comparisons of individuals with different
endowments (cash on hand and expected labor income). The economic interpretation
of ∆W0 / W0 is the answer to the following question: How much wealthier, on an
expected utility basis, would an investor feel if he or she chose an asset allocation
according to the benchmark model? Small values of ∆W0 / W0 indicate that changing
asset allocation toward the normative result would not enhance expected utility a lot,
whereas large values of ∆W0 / W0 indicate that the individual could be considerably
better off—that is, he or she gives away a lot of utility by not following the
benchmark model. Thus, another interpretation of ∆W0 / W0 is that it measures the
welfare loss due to suboptimal behavior.

The specification of V0^act(W0, L0) includes the actual behavior with respect to asset
allocation, as predicted by the regression equation of the tobit model. The decision
with respect to consumption Ct(Wt) (and saving) is assumed to follow the normative

¹⁸ See Appendix A.

22

<<   20   21   22   23   24   25   26   >>

More intriguing information