Can the Risk of Medical Expenditure Explainthe Wealth Trajectories of Elderly Singles?

Abstract

In this article, I analyze the role of precautionary savings as a determinant of the wealth holdings of elderly singles. The novel aspect of the analysis is that the distribution of medical expenditure is allowed to be individual-specific, and the variance of medical expenditure is estimated for each individual using repeated observations on medical expenditure. To address the measurement error problem in medical expenditure, I use an instrumental variable estimator. I construct a simple life-cycle model and show that the coefficient of relative risk aversion can be identified from a log-linearized Euler equation for wealth, using the variation in the risk of medical expenditure. The results imply that precautionary savings can account for up to 56% of the wealth holdings of elderly singles. This means lowering the risk exposure of medical expenses at older ages could significantly alter the retirement asset draw-down rates and strategies.