Life-cycle modeling of bequests and their impact on annuity valuation

In this paper we introduce a linear bequest motive into a standard life-cycle model, both allowing for credit and annuity market imperfections. First, we characterize the consumption and wealth processes. We find that consumption is non-increasing in the linear bequest parameter for the simplest certainty case, but that the same is not true for life-span uncertainty. Second, we study the issue of annuity valuation. For a sufficiently strong bequest motive, the true value of an annuity is equal to the actuarial value. This invalidates a previous claim that, for imperfect annuity markets, it is close to the simple financial value. (C) 2001 Elsevier Science BN. All rights reserved.