Modeling retirees’ investment behaviors in the presence of health expenditure risk and financial crisis risk

Abstract

This paper examines the impact of both health risks and financial market turmoil on individual investment decisions during retirement. Using a panel data set compiled from the U.S. Health and Retirement Survey, we find that health shocks increase retirees’ disposable income uncertainty and compromise their risk-taking capacity. This is especially the case for those with moderate levels of wealth. However, we find that health risk alone cannot explain the empirically observed lower level of risky asset investment behaviors. It is the presence of extreme events in the financial markets, in combination with health risks, that significantly reduce retirees’ incentives to invest in risky assets. Compared with younger investors, retirees’ shorter investment horizon and higher health risks render them more vulnerable to the detrimental consequences of wealth evaporation caused by financial crises. Our results indicate that effective portfolio management for retirees must take into account both their health risks and the occurrence of financial market tail risks.