“Uncertain Medical Expenses and Portfolio Choice Over the Life Cycle” by Jia LUO
In this paper, I explore the effects of uninsurable risk of health expenditures as well as labor income risk on portfolio choice in a realistically calibrated life-cycle model. Most of the existing literature that examines labor income risk and its effect on portfolio composition over the life cycle can provide compelling explanations for the vast differences in portfolios between young and old investors; but few of these studies can explain continued declines in risk-taking with age after retirement. This paper uses MEPS (Medical Expenditure Panel Survey) and HRS (Health and Retirement Study) data to calibrate uncertain medical expenses for the retired. With the consideration of idiosyncratic health expense risk in addition to labor income risk, the model can generate declining financial risk-taking with age after retirement, and therefore fits the data much better than those studies which consider labor income alone. Additionally, regressions on simulated data also show that investors with poorer health tend to hold a smaller share of stocks in their portfolios, which is consistent with the empirical pattern of portfolio choice. Finally, using the model I have developed, I predict the impact of changes in government health insurance programs, such as the expansion of the Medicare program, on individuals’ portfolio choices. Simulated results show that a more generous Medicare policy significantly increases the proportion of financial wealth held in equities for the retired.