Markets have become increasingly volatile in recent times. A model is defined that identifies a specific insurance premium for individual portfolio protection against a pre-determined level of volatility. A utility model is defined based on individuals' unique preferences with respect to consumption and leisure time. The certainty equivalent framework is applied to this time utility model to calculate specific insurance premiums for risk-averse investors who desire the optimization of leisure time and consumption. Traditional asset allocation models often assume individuals desire the maximization of wealth and ignore the fact that individuals value leisure time. Thus, practitioners often rely on rules of thumb to reduce equity allocations based on an individual's age. As individuals approach their retirement age, their concern for volatility increases. In essence, individuals are cognizant of their limited amount of time and realize that time diversification of risk no longer applies to them personally. In the event that expected returns are not realized, regardless of what traditional economic theory suggests regarding the maximization of wealth, individuals will sacrifice leisure time and consumption. It is rather curious that the average individual purchases automobile insurance and home insurance but often does not insure his or her most significant investment, the retirement portfolio, as retirement approaches. The model developed in this article provides a rational approach for justifying and quantifying the cost of insuring portfolios for risk-averse individuals. The utility function is derived for individuals based on their unique preferences of time and wealth.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics