City Research Online

Cumulative Prospect Theory and Deferred Annuities

Chen, A., Haberman, S. & Thomas, S. (2019). Cumulative Prospect Theory and Deferred Annuities. Review of Behavioural Finance, 11(3), pp. 277-293. doi: 10.1108/rbf-10-2017-0102


Purpose – Although it has been proved theoretically that annuities can provide optimal consumption during one’s retirement period, retirees’ reluctance to purchase annuities is a long-standing puzzle. The purpose of this paper is to use behavioral model to analyse the low demand for immediate annuities.

Design/methodology/approach – The authors employ Cumulative Prospect Theory (CPT), which contains both loss aversion and probability transformations, to analyse the annuity puzzle.

Findings – The authors show that Cumulative Prospect Theory (CPT) can explain the unattractiveness of immediate annuities. It also shows that retirees would be willing to buy a long-term deferred annuity at retirement. By considering each component from CPT in turn, the loss aversion is found to be the major reason that stops people from buying an annuity; while the survival rate transformation is an important factor affecting the decision of when to receive annuity incomes.

Originality/value – This paper identifies CPT as one of the reasons for the low demand of immediate annuities. It further suggests that long-term deferred annuities could overcome behavioral obstacles and become popular among retirees.

Publication Type: Article
Additional Information: Published by Emerald 2017.
Departments: Bayes Business School > Actuarial Science & Insurance
Bayes Business School > Finance
SWORD Depositor:
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