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This project evaluates how workers might invest their Personal Retirement Account
(PRA) funds between safe and risky assets, depending on whether they are offered a rate
of return guarantee on the risky asset. We focus on how asset allocation decisions might
differ depending on participants’ attitudes about risk and regret. If, for example, the
return on the risky asset turns out to be very high when a worker retires, he might regret
not having allocated a large enough portion of his contributions to the risky asset. On the
contrary, if the stock market does poorly, the retiree might regret having invested at all in
that asset. We show that anticipated disutility from regret can have a potent effect on
investment choices in a PRA. If there is no guarantee, regret induces investors to move
away from extreme decisions: that is, investors who take regret into account hold less
stock if the risk premium is high, but more stocks if the risk premium is low. Further, a
rate of return guarantee provided at no cost to the plan participant induces him to hold
more stocks, with or without regret. We also show that, with or without regret, investors'
willingness to pay for a guarantee rises with the level of the guaranteed return. This
research could be informative regarding the potential profitability of the guaranteed
pension business, which would help determine whether a government subsidy would be
required to bring these products to market.
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