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Market Valuation of Accrued Social Security Benefits

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  • John Geanakoplos
  • Stephen P. Zeldes

Abstract

One measure of the health of the Social Security system is the difference between the market value of the trust fund and the present value of benefits accrued to date. How should present values be computed for this calculation in light of future uncertainties? We think it is important to use market value. Since claims on accrued benefits are not currently traded in financial markets, we cannot directly observe a market value. In this paper, we use a model to estimate what the market price for these claims would be if they were traded. In valuing such claims, the key issue is properly adjusting for risk. The traditional actuarial approach - the approach currently used by the Social Security Administration in generating its most widely cited numbers - ignores risk and instead simply discounts "expected" future flows back to the present using a risk-free rate. If benefits are risky and this risk is priced by the market, then actuarial estimates will differ from market value. Effectively, market valuation uses a discount rate that incorporates a risk premium. Developing the proper adjustment for risk requires a careful examination of the stream of future benefits. The U.S. Social Security system is "wage-indexed": future benefits depend directly on future realizations of the economy-wide average wage index. We assume that there is a positive long-run correlation between average labor earnings and the stock market. We then use derivative pricing methods standard in the finance literature to compute the market price of individual claims on future benefits, which depend on age and macro state variables. Finally, we aggregate the market value of benefits across all cohorts to arrive at an overall value of accrued benefits. We find that the difference between market valuation and "actuarial" valuation is large, especially when valuing the benefits of younger cohorts. Overall, the market value of accrued benefits is only 4/5 of that implied by the actuarial approach. Ignoring cohorts over age 60 (for whom the valuations are the same), market value is only 70% as large as that implied by the actuarial approach.

Suggested Citation

  • John Geanakoplos & Stephen P. Zeldes, 2009. "Market Valuation of Accrued Social Security Benefits," NBER Working Papers 15170, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:15170
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    References listed on IDEAS

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    1. Luca Benzoni & Pierre Collin‐Dufresne & Robert S. Goldstein, 2007. "Portfolio Choice over the Life‐Cycle when the Stock and Labor Markets Are Cointegrated," Journal of Finance, American Finance Association, vol. 62(5), pages 2123-2167, October.
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    3. John Geanakoplos & Stephen P. Zeldes, 2009. "Reforming Social Security with Progressive Personal Accounts," NBER Chapters, in: Social Security Policy in a Changing Environment, pages 73-121, National Bureau of Economic Research, Inc.
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    Cited by:

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    3. Alexander W. Blocker & Laurence J. Kotlikoff & Stephen A. Ross & Sergio Villar Vallenas, 2019. "The True Cost of Social Security," Tax Policy and the Economy, University of Chicago Press, vol. 33(1), pages 131-163.
    4. Frank Jong, 2012. "Portfolio Implications of Cointegration Between Labor Income and Dividends," De Economist, Springer, vol. 160(4), pages 397-412, December.
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    6. Ilja Boelaars & Roel Mehlkopf, 2018. "Optimal risk-sharing in pension funds when stock and labor markets are co-integrated," DNB Working Papers 595, Netherlands Central Bank, Research Department.
    7. Erzo F. P. Luttmer & Andrew A. Samwick, 2018. "The Welfare Cost of Perceived Policy Uncertainty: Evidence from Social Security," American Economic Review, American Economic Association, vol. 108(2), pages 275-307, February.
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    More about this item

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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