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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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File URL: http://www.oenb.at/dms/oenb/Publikationen/Volkswirtschaft/Working-Papers/2008/Working-Paper-146/fullversion/wp146_tcm16-92027.pdf
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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. 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.
  2. A. Abel, 2010. "Asset prices under habit formation and catching up with the Jones," Levine's Working Paper Archive 1395, David K. Levine.
  3. Lindbeck, Assar & Persson, Mats, 2002. "The Gains from Pension Reform," Seminar Papers 712, Stockholm University, Institute for International Economic Studies.
  4. Clark, Andrew E. & Frijters, Paul & Shields, Michael A., 2007. "Relative Income, Happiness and Utility: An Explanation for the Easterlin Paradox and Other Puzzles," IZA Discussion Papers 2840, Institute for the Study of Labor (IZA).
  5. 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.
  6. Frank, Robert H., 1993. "Choosing the Right Pond: Human Behavior and the Quest for Status," OUP Catalogue, Oxford University Press, number 9780195049459, March.
  7. 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.
  8. Dirk Krueger & Felix Kubler, 2003. "Pareto Improving Social Security Reform when Financial Markets are Incomplete?," NBER Working Papers 9410, National Bureau of Economic Research, Inc.
  9. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," NBER Working Papers 8074, National Bureau of Economic Research, Inc.
  10. 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.
  11. 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.
  12. 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.
  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. 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.
  15. Feldstein, Martin, 1996. "The Missing Piece in Policy Analysis: Social Security Reform," American Economic Review, American Economic Association, vol. 86(2), pages 1-14, May.
  16. 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.
  17. Christopher D Carroll, 1997. "Why Do the Rich Save So Much?," Economics Working Paper Archive 388, The Johns Hopkins University,Department of Economics.
  18. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  19. Markus Knell, 1999. "Social Comparisons, Inequality, and Growth," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(4), pages 664-, December.
  20. Ranguelova, Elena & Feldstein, Martin, 2001. "Individual Risk in an Investment-Based Social Security System," Scholarly Articles 2797440, Harvard University Department of Economics.
  21. 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.
  22. Sen, Amartya, 1983. "Poor, Relatively Speaking," Oxford Economic Papers, Oxford University Press, vol. 35(2), pages 153-69, July.
  23. 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.
  24. Boskin, Michael J & Sheshinski, Eytan, 1978. "Optimal Redistributive Taxation when Individual Welfare Depends upon Relative Income," The Quarterly Journal of Economics, MIT Press, vol. 92(4), pages 589-601, November.
  25. 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.
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