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Risk Management of Pension Systems from the Perspective of Loss Aversion


  • Johannes Binswanger


This paper studies pension design from a risk management point of view using a lexicographic loss aversion model. Interest in this model stems from the fact that it explains income expansion paths of equity and total savings particularly well. I find that all income groups are likely to benefit from a PAYGO system, even in the absence of any redistribution. Optimal equity investments are close to zero for the two bottom income quintiles and increase sharply for higher incomes. The results are compared to optimal pension plans under HARA preferences. I find that a PAYGO system has higher value under loss aversion than in the HARA case. Moreover, equity shares correspond more closely to empirical observations.

Suggested Citation

  • Johannes Binswanger, 2005. "Risk Management of Pension Systems from the Perspective of Loss Aversion," CESifo Working Paper Series 1572, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_1572

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    References listed on IDEAS

    1. Francisco Gomes & Alexander Michaelides, 2003. "Portfolio Choice With Internal Habit Formation: A Life-Cycle Model With Uninsurable Labor Income Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 729-766, October.
    2. 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.
    3. John Y. Campbell & João F. Cocco & Francisco J. Gomes & Pascal J. Maenhout, 2001. "Investing Retirement Wealth: A Life-Cycle Model," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 439-482 National Bureau of Economic Research, Inc.
    4. Michael Haliassos, 2002. "Stockholding: Recent Lessons from Theory and Computations," University of Cyprus Working Papers in Economics 0206, University of Cyprus Department of Economics.
    5. James M. Poterba & Joshua Rauh & Steven F. Venti, 2005. "Utility Evaluation of Risk in Retirement Saving Accounts," NBER Chapters,in: Analyses in the Economics of Aging, pages 13-58 National Bureau of Economic Research, Inc.
    6. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249, January.
    7. Luigi Guiso & Tullio Jappelli, 2002. "Stockholding in Italy," CSEF Working Papers 82, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    8. Karen E. Dynan & Jonathan Skinner & Stephen P. Zeldes, 2004. "Do the Rich Save More?," Journal of Political Economy, University of Chicago Press, vol. 112(2), pages 397-444, April.
    9. Cass, David & Stiglitz, Joseph E., 1970. "The structure of investor preferences and asset returns, and separability in portfolio allocation: A contribution to the pure theory of mutual funds," Journal of Economic Theory, Elsevier, vol. 2(2), pages 122-160, June.
    10. Marianne Baxter & Robert G. King, 2001. "The Role of International Investment in a Privatized Social Security System," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 371-438 National Bureau of Economic Research, Inc.
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    Cited by:

    1. Kai Konrad & Stergios Skaperdas, 2012. "The market for protection and the origin of the state," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 50(2), pages 417-443, June.

    More about this item


    pension system; portfolio choice; income heterogeneity; loss aversion; HARA preferences;

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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