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Rational Overconfidence and Social Security

  • Carsten Krabbe Nielsen

    ()

    (Istituto Politica Economica, Universita Cattolica and Korea University)

Two of the features that distinguish Social Security and many other state mandated pension plans around the world are that (i) a minimum level of savings for retirement is imposed on most citizens and (ii) individuals cannot decide how their contributions are invested. Here, a rationale for these two features, based on ratoinal overconfidence, is proposed. Rational overconfidence is present when equally informed agents hold diverse confident, rational beliefs. The fact that beliefs are diverse means that all of them cannot be correct, hence seen as a collective agents do not act optimally. In the face of rational overconfidence, Pareto efficiency is no long the natural criterion for comparing policies and we suggest ex-post welfare optimality instead. This criterion makes amends for the possible inconsistencies of agents beliefs. Our results on social security are based on a methodology that places itself strictly between the traditional neoclassical approach and that championed by behavioral economics. This methodology does not deviate from the neoclassical assumption of ratoinality but only broadens it and can therefore readily be applied to many public policy issues.

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File URL: http://econ.korea.ac.kr/~ri/WorkingPapers/w0916.pdf
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Paper provided by Institute of Economic Research, Korea University in its series Discussion Paper Series with number 0916.

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Length: 29 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:iek:wpaper:0916
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