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The Optimal Mix Between Funded and Unfunded Pensions System When People Care About Relative Consumption

In this paper I derive the optimal portfolio mix between a funded and an unfunded pension system when people care about their consumption relative to a reference group. Pay-as-you-go systems with fixed contribution rates have the property that pension benefits are tied to labor income. This lowers the uncertainty of individuals’future relative position and thus increases the attractiveness of unfunded systems. The paper shows analytically that in an OLG model the optimal share of funding decreases with the strength of individuals’ concern for relative standing. A calibrated version of the model that uses data for various countries and time periods suggests that the sensitivity of the optimal share of funding to the concern of relative standing is also quantitatively important. For reasonable assumptions about reference standards it is typically around 20%.

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Paper provided by Oesterreichische Nationalbank (Austrian Central Bank) in its series Working Papers with number 146.

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Length: 43
Date of creation: 01 Sep 2008
Date of revision:
Handle: RePEc:onb:oenbwp:146
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  1. Abel, Andrew B, et al, 1989. "Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, Wiley Blackwell, vol. 56(1), pages 1-19, January.
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  3. Krueger, Dirk & Kübler, Felix, 2005. "Pareto Improving Social Security Reform when Financial Markets Are Incomplete," CEPR Discussion Papers 5039, C.E.P.R. Discussion Papers.
  4. Lindbeck, Assar & Persson, Mats, 2002. "The Gains from Pension Reform," Seminar Papers 712, Stockholm University, Institute for International Economic Studies.
  5. Markus Knell, . "Social Comparisons, Inequality, and Growth," IEW - Working Papers 005, Institute for Empirical Research in Economics - University of Zurich.
  6. Meyer, Donald J. & Meyer, Jack, 2005. "Risk preferences in multi-period consumption models, the equity premium puzzle, and habit formation utility," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1497-1515, November.
  7. Henning Bohn, 1999. "Social Security and Demographic Uncertainty: The Risk Sharing Properties of Alternative Policies," NBER Working Papers 7030, National Bureau of Economic Research, Inc.
  8. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," American Economic Review, American Economic Association, vol. 91(4), pages 1116-1125, September.
  9. Olof Johansson-Stenman & Fredrik Carlsson & Dinky Daruvala, 2002. "Measuring Future Grandparents" Preferences for Equality and Relative Standing," Economic Journal, Royal Economic Society, vol. 112(479), pages 362-383, April.
  10. Andrew B. Abel, 2005. "Optimal Taxation when Consumers Have Endogenous Benchmark Levels of Consumption," Review of Economic Studies, Oxford University Press, vol. 72(1), pages 21-42.
  11. De Menil, Georges & Murtin, Fabrice & Sheshinski, Eytan, 2006. "Planning for the optimal mix of paygo tax and funded savings," Journal of Pension Economics and Finance, Cambridge University Press, vol. 5(01), pages 1-25, March.
  12. Andrew E. Clark & Paul Frijters & Michael A. Shields, 2008. "Relative income, happiness, and utility: An explanation for the Easterlin paradox and other puzzles," Post-Print halshs-00754299, HAL.
  13. Matsen, Egil & Thogersen, Oystein, 2004. "Designing social security - a portfolio choice approach," European Economic Review, Elsevier, vol. 48(4), pages 883-904, August.
  14. repec:tpr:qjecon:v:92:y:1978:i:4:p:589-601 is not listed on IDEAS
  15. Frank, Robert H., 1993. "Choosing the Right Pond: Human Behavior and the Quest for Status," OUP Catalogue, Oxford University Press, number 9780195049459, July.
  16. Dutta, Jayasri & Kapur, Sandeep & Orszag, J. Michael, 2000. "A portfolio approach to the optimal funding of pensions," Economics Letters, Elsevier, vol. 69(2), pages 201-206, November.
  17. Clark, Andrew E. & Oswald, Andrew J., 1998. "Comparison-concave utility and following behaviour in social and economic settings," Journal of Public Economics, Elsevier, vol. 70(1), pages 133-155, October.
  18. Martin Feldstein, 1996. "The Missing Piece in Policy Analysis: Social Security Reform," NBER Working Papers 5413, National Bureau of Economic Research, Inc.
  19. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  20. Andreas Wagener, 2003. "Pensions as a portfolio problem: fixed contribution rates vs. fixed replacement rates reconsidered," Journal of Population Economics, Springer, vol. 16(1), pages 111-134, 02.
  21. Sen, Amartya, 1983. "Poor, Relatively Speaking," Oxford Economic Papers, Oxford University Press, vol. 35(2), pages 153-69, July.
  22. Christopher D Carroll, 1997. "Why Do the Rich Save So Much?," Economics Working Paper Archive 388, The Johns Hopkins University,Department of Economics.
  23. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
  24. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  25. Ranguelova, Elena & Feldstein, Martin, 2001. "Individual Risk in an Investment-Based Social Security System," Scholarly Articles 2797440, Harvard University Department of Economics.
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