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Optimal intergenerational risk sharing

Hemert, Otto van (2005) Optimal intergenerational risk sharing. Discussion paper: UBS Pensions Series 037, 541. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Abstract

This paper studies optimal intergenerational transfer policy under stochastic labor income and capital returns. It has implications for Social Security, government tax and debt policy, and DB pension funds. A stylized two-period overlapping-generations model is developed where a central planner implements pay-as-you-go transfers. I allow for autocorrelation in the labor income and skewness in the capital return and calibrate the model parameters to US data. I show that state-contingent transfers facilitate intergenerational risk sharing in a way that is similar to portfolio insurance using put options. That is, the working generation provides downside risk insurance to the old on their savings. In addition, when no riskfree asset is available, these transfers improve utility by substituting for this missing asset. I further find that imposing an incentive constraint for the working generation has little impact when transfers also have this substitution role, but it causes the transfer scheme to collapse to the zero-transfer scheme when a risk free asset is available.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2005 The Author
Library of Congress subject classification: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 541
Date Deposited: 30 Jul 2009 09:28
URL: http://eprints.lse.ac.uk/24660/

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