Bridge over ocean
26 October 2006 Multimedia

The Theory of Optimal Life-Cycle Theory Saving and Investing—Part I

  1. Zvi Bodie, PhD
  2. Paul S. Willen, PhD
  3. Jonathan Treussard

How much should a family save for retirement and the kids' college education, and how much insurance should they buy for health care, disability, long-term care, and other contingencies? What should a company choose as the default asset allocation for a mandatory retirement saving plan? Bodie, Treussard, and Willen believe that economic theory provides guidance for making such decisions. The modern theory of household financial planning as developed by Fisher, Modigliani, Duesenberry, Arrow, Debreu, Samuelson, Merton, and others provides the right analytical framework and key insights. Recent work has extended the theory to account for real-world problems such as borrowing and short-sale constraints, illiquid and non-tradeable assets and transactions costs. But a gap still remains between what people do and what theory says they should do—a gap the authors attribute partially to the institutional and intellectual complexity of our theoretically optimal plans. Many of these shortcomings can be addressed by innovative financial products made feasible by recent advances in financial technology. One question remains though: Will existing providers of financial services be the ones to innovate further or will new institutions be needed?

Please note that text may be difficult to read in this recording. The presentation slides are available for download in the video player.

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