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A Life-Cycle Model with Ambiguous Survival Beliefs

Max Groneck, Alexander Ludwig and Alexander Zimper
University of Cologne, Working Paper Series in Economics No. 63, 2013

JEL codes: D91, D83, E21

Keywords: Cumulative prospect theory, Choquet expected utility, Dynamic inconsistency, Life-cycle hypothesis, Saving puzzles

On average, "young" people underestimate whereas "old" people overestimate their chances to survive into the future. We adopt a Bayesian learning model of ambiguous survival beliefs which replicates these patterns. The model is embedded within a non-expected utility model of life-cycle consumption and saving. Our analysis shows that agents with ambiguous survival beliefs (i) save less than originally planned, (ii) exhibit undersaving at younger ages, and (iii) hold longer on to their assets than their rational expectations counterparts who correctly assess survival probabilities. Our ambiguity- driven model therefore simultaneously accounts for three important empirical findings on household saving behavior.

A Life-Cycle Model with Ambiguous Survival Beliefs