Household Responses to Social Security Policy Risk

We examine the optimal consumption/saving and portfolio allocation responses of rational households subject to an exogenous change in the terms of the Social Security contract. Our analysis uses key features of the actual contract, an exogenous labor income process calibrated to IRS administrative records, and one-time random shocks that are calibrated to the intermediary assumptions of the Social Security Administration's actuary. Our calibrated experiments show that inaction following a policy shock, on its own, does not imply inattention or some other form of behavioral decision making. Inaction is a common occurrence in the optimal responses of rational households of different ages and wealth levels given realistic levels of background risk