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Designing social security - a portfolio choice approach

  • Matsen, Egil
  • Thogersen, Oystein

Public social security systems may provide diversification of risks to individuals’ life-time income. Capturing that a pay-as-you-go program (paygo) may be considered as a “quasiasset”, we study the optimal size of the social security program as well as the optimal split between a funded part and a paygo part by means of a theoretical portfolio choice approach. A low-yielding paygo system can benefit individuals if it contributes to hedge other risks to their lifetime resources. Moreover, a funded part of the social security system can be justified by potential imperfections to the individuals’ free access to the stock market. Numerical calculations for Sweden, Norway, the US and the UK demonstrate that the optimal size of paygo-part of the pension program varies considerably in response to differences in projected growth rates and the correlation between stock returns and growth. Our calculations suggest that a paygo program has an important role in the three former countries – but not in the U.K.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 48 (2004)
Issue (Month): 4 (August)
Pages: 883-904

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Handle: RePEc:eee:eecrev:v:48:y:2004:i:4:p:883-904
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