Risk Management of Pension Systems from the Perspective of Loss Aversion
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.
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