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Intergenerational risk sharing under loss averse preferences

Author

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  • Boes, Mark-Jan
  • Siegmann, Arjen

Abstract

Individual retirement savings schemes could benefit from risk-sharing mechanisms between generations that take behavioral aspects into account. We introduce a novel risk-sharing mechanism that incorporates nominal loss-aversion in two ways. First, the system avoids out-of-pocket wealth transfers by sharing only a fraction of positive returns over a high-water mark of pension assets. Secondly, payments from a generation insurance fund are targeted at nominal pension shortfalls below a reference point, which mitigates the loss experience at retirement. From a simulation of overlapping generations with stochastic asset returns and interest rates we find that the generation insurance scheme outperforms a pure individual retirement scheme by a significant margin: a similar risk of pension shortfall can be achieved with a contribution rate that is up to 20% lower. The efficiency gains vary with the extent of risk sharing over generations but remain large for sensible parameter values.

Suggested Citation

  • Boes, Mark-Jan & Siegmann, Arjen, 2018. "Intergenerational risk sharing under loss averse preferences," Journal of Banking & Finance, Elsevier, vol. 92(C), pages 269-279.
    • Handle: RePEc:eee:jbfina:v:92:y:2018:i:c:p:269-279
    DOI: 10.1016/j.jbankfin.2016.08.001
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    Cited by:

    1. Bégin, Jean-François, 2020. "Levelling the playing field: A VIX-linked structure for funded pension schemes," Insurance: Mathematics and Economics, Elsevier, vol. 94(C), pages 58-78.

    More about this item

    Keywords

    Retirement saving; Loss aversion; Risk sharing; Insurance; Collective defined-contribution (CDC);
    All these keywords.

    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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