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Labor Income and the Design of Default Portfolios in Mandatory Pension Systems: An Application to Chile

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  • Sánchez Martín, A.
  • Jiménez Martín, S.
  • Robalino, D.
  • Todeschini, F.

Abstract

Governments often impose choices regarding the levels of savings and the composition of the portfolio of assets in mandatory pension systems; either the share of pay-as-you-go vs. financial assets or the structure of default portfolios to which a majority of workers stick. Yet, it is well known that the optimal savings rate and the structure of the portfolio of assets depend on individual preferences and the properties of human capital. For example, workers whose labor income is very volatile or is highly correlated with the returns on risky financial assets should tilt their portfolios towards safe assets early in life. In this paper we explore the potential welfare gains derived from incorporating this basic principle into the design of the default portfolios offered by DC pension plans, based on the case of the Chilean pension system. We estimate the properties of labor earnings for several representative individuals, simulate their optimal life-cycle portfolio choices and compare with the current institutional defaults. We find very sizable welfare improvements for several of the groups of workers studied. The results suggest that policymakers should take into account education and occupation when defining portfolio defaults. These principles apply more generally to the choice between pay-as-you-go vs. financial assets – and we argue – could improve incentive for some groups to contribute.

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Paper provided by FEDEA in its series Working Papers with number 2012-04.

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Date of creation: May 2012
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Handle: RePEc:fda:fdaddt:2012-04

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  1. Bovenberg, A.L. & Koijen, R.S.J. & Nijman, T.E. & Teulings, C.N., 2007. "Saving and investing over the life cycle and the role of collective pension funds," Open Access publications from Tilburg University urn:nbn:nl:ui:12-301942, Tilburg University.
  2. David Miles & Ales Cerny, 2006. "Risk, Return and Portfolio Allocation under Alternative Pension Systems with Incomplete and Imperfect Financial Markets," Economic Journal, Royal Economic Society, vol. 116(511), pages 529-557, 04.
  3. Andrea Repetto & Cristobal Huneeus, 2004. "The Dynamics of Earnings in Chile," Econometric Society 2004 Latin American Meetings 251, Econometric Society.
  4. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Solange Berstein & Olga Fuentes & Nicolás Torrealba, 2011. "Esquema de Multifondos en Chile," Working Papers 43, Superintendencia de Pensiones, revised Jan 2011.
  6. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2002. "Consumption and Risk Sharing Over the Life Cycle," Seminar Papers 702, Stockholm University, Institute for International Economic Studies.
  7. Shlomo Benartzi & Richard Thaler, 2007. "Heuristics and Biases in Retirement Savings Behavior," Journal of Economic Perspectives, American Economic Association, vol. 21(3), pages 81-104, Summer.
  8. Solange Berstein & Olga Fuentes & Nicolás Torrealba, 2011. "La Importancia de la Opción por Omisión en los Sistemas de Pensiones de Cuentas Individuales," Working Papers 44, Superintendencia de Pensiones, revised Jan 2011.
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Cited by:
  1. Bremus, Franziska M. & Kuzin, Vladimir, 2014. "Unemployment and portfolio choice: Does persistence matter?," Journal of Macroeconomics, Elsevier, vol. 40(C), pages 99-113.
  2. Markus Brückner & Antonio Ciccone & Andrea Tesei, 2013. "Oil Price Shocks, Income, and Democracy," Working Papers 2013-18, FEDEA.

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