Funded pensions and intergenerational and international risk sharing in general equilibrium

We explore intergenerational and international risk sharing in a general equilibrium multiple-country model with two-tier pensions systems. The exact design of the pension system is key for the way in which risks are shared over generations. The laissez-faire market solution fails to provide an opti...

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Bibliographic Details
Published in:Journal of international money and finance 2011-11, Vol.30 (7), p.1516-1534
Main Authors: Beetsma, Roel M.W.J., Bovenberg, A. Lans, Romp, Ward E.
Format: Article
Language:English
Subjects:
Bonds
Defined wage-indexed benefits
Economic models
Economic theory
Financial risks
Funded pensions
General economic equilibrium
Intergenerational relations
International relations
Liberalism
Overlapping generations
Pension funds
Pensions
Risk sharing
Studies
Wage-indexed bonds
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Summary:We explore intergenerational and international risk sharing in a general equilibrium multiple-country model with two-tier pensions systems. The exact design of the pension system is key for the way in which risks are shared over generations. The laissez-faire market solution fails to provide an optimal allocation because the young cannot share in the financial risks. However, the existence of wage-indexed bonds combined with a pension system with a fully funded second tier that pays defined wage-indexed benefits can reproduce the first best. If wage-indexed bonds are not available, mimicking the first best is not possible, except under special circumstances. We also explore whether national pension funds want to deviate from the first best by increasing domestic equity holdings. With wage-indexed bonds this incentive is absent, while there is indeed such an incentive when wage-indexed bonds do not exist. ► We study risk sharing in a multi-country two-tier pension system. ► Under a laissez-fair market solution young cannot share in the financial risks. ► Two-tier system can mimic optimal international and intergenerational allocation. ► Wage-indexed bonds are necessary to replicate first-best allocation. ► Each country wants to deviate from the first best by holding more domestic equity.
ISSN:0261-5606
1873-0639
DOI:10.1016/j.jimonfin.2011.07.001