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Social Security Investment in Equities I: Linear Case

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  • Peter Diamond
  • Jean Geanakoplos

Abstract

Social Security trust fund portfolio diversification to include some equities reduces the equity premium by raising the safe real interest rate. This requires changes in taxes. Under the hypothesis of constant marginal returns to risky investments, trust fund diversification lowers the price of land, increases aggregate investment, and raises the sum of household utilities, suitably weighted. It makes workers who do not own equities on their own better off, though it may hurt some others since changed taxes and asset values redistribute wealth across contemporaneous households and across generations. In our companion paper we reconsider the effects of diversification when there are decreasing marginal returns to safe and risky investment. Our analysis uses a two-period overlapping generations general equilibrium model with two types of agents, savers and workers who do not save. The latter represent approximately half of all workers who hold no equities whatsoever.

Suggested Citation

  • Peter Diamond & Jean Geanakoplos, 1999. "Social Security Investment in Equities I: Linear Case," NBER Working Papers 7103, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:7103
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    References listed on IDEAS

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    1. John Geanakoplos & Olivia S. Mitchell & Stephen P. Zeldes, "undated". "Social Security Money's Worth," Pension Research Council Working Papers 97-20, Wharton School Pension Research Council, University of Pennsylvania.
    2. Arthur B. Kennickell & Martha Starr-McCluer & Annika E. Sunden, 1997. "Family Finance in the U.S.: Recent Evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), vol. 83(1), pages .1-24, January.
    3. Olivia S. Mitchell & James F. Moore, "undated". "Retirement Wealth Accumulation and Decumulation: New Developments and Outstanding Opportunities," Pension Research Council Working Papers 97-8, Wharton School Pension Research Council, University of Pennsylvania.
    4. Diamond, Peter A & Yaari, Menahem, 1972. "Implications of the Theory of Rationing for Consumer Choice Under Uncertainty," American Economic Review, American Economic Association, vol. 62(3), pages 333-343, June.
    5. Peter Diamond, 2004. "Social Security," American Economic Review, American Economic Association, vol. 94(1), pages 1-24, March.
    6. Peter A. Diamond, 1997. "Macroeconomics Aspects of Social Security Reform," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 1-88.
    7. Henning Bohn, 1997. "Social Security reform and financial markets," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, issue jun, pages 193-227.
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    Cited by:

    1. Saku Aura & Peter Diamond & John Geanakoplos, 2002. "Savings and Portfolio Choice in a Two-Period Two-Asset Model," American Economic Review, American Economic Association, vol. 92(4), pages 1185-1191, September.
    2. Kent Smetters, 2001. "The Equivalence of the Social Security's Trust Fund Portfolio Allocation and Capital Income Tax Policy," NBER Working Papers 8259, National Bureau of Economic Research, Inc.
    3. Menezes, Carmen F. & Henry Wang, X. & Bigelow, John P., 2005. "Duality and consumption decisions under income and price risk," Journal of Mathematical Economics, Elsevier, vol. 41(3), pages 387-405, April.
    4. Andrew B. Abel, 2001. "The Effects of Investing Social Security Funds in the Stock Market When Fixed Costs Prevent Some Households from Holding Stocks," American Economic Review, American Economic Association, vol. 91(1), pages 128-148, March.
    5. Eisen, Roland, 2000. "(Partial) privatization social security: The Chilean model - a lesson to follow?," CFS Working Paper Series 2000/13, Center for Financial Studies (CFS).
    6. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324, Elsevier.
    7. Assaf Razin & Efraim Sadka, 2003. "Privatizing Social Security Under Balanced-Budget Constraints: A Political-Economy Approach," CESifo Working Paper Series 1039, CESifo.
    8. Peter A. Diamond, 1999. "What Stock Market Returns To Expect For The Future?," Issues in Brief ib-2, Center for Retirement Research.
    9. Deborah Lucas & Marvin Phaup, 1975. "The Cost of Risk to the Government and Its Implications for Federal Budgeting," NBER Chapters, in: Measuring and Managing Federal Financial Risk, pages 29-54, National Bureau of Economic Research, Inc.
    10. Simon Grant & John Quiggin, 2002. "The Risk Premium for Equity: Implications for the Proposed Diversification of the Social Security Fund," American Economic Review, American Economic Association, vol. 92(4), pages 1104-1115, September.
    11. Lyon, Andrew B. & Stell, John L., 2000. "Analysis of Current Social Security Reform Proposals," National Tax Journal, National Tax Association, vol. 53(n. 3), pages 473-514, September.

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    More about this item

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • E66 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General Outlook and Conditions

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