2009), Optimal Annuitization with Background Risk and Equity Exposure During Retirement, working paper, available at http://ssrn.com/abstract=1341674

We analyze annuity demand in a realistic life-cycle model in which we optimize over consumption and asset allocation. We incorporate background risk and incomplete annuity menus as possible drivers of devia-tions from full annuitization. Retirees face longevity risk, capital market risk, inflation risk, and background risk. We model annuitization as a one-time decision at retirement. Contrary to what is often suggested in the literature, we find that in these settings full annuitization remains close to optimal, irrespective of whether real or only nominal annuities are available. Under all circumstances we find optimal annuitization levels above 95 % of initial wealth. On the one hand annuitization is attractive due to the additional wealth created by the mortality credit, on the other hand annuities are irreversible and the annuity menu is incomplete. We show that the additional wealth effect dominates, optimally individuals annuitize almost their entire wealth at retirement to capture the mortality credit. Whenever liquidity or equity exposure is desired, individuals save sizeable amounts out of their annuity income to smooth shocks due to background or inflation risk and/or to get equity exposure. We can identify this result, because we do not assume a priori that consump-tion equals annuity income in retirement and solve a dynamic programming problem for consumption and savings. Similarly, adding variable annuities to the menu does not increase welfare significantly, since indi