Age-Dependent Risk Aversion: Re-evaluating Fiscal Policy Impacts of Population Aging

The integration of age-dependent increasing risk aversion (IRA) into an overlapping generations model (OLG) with risk-sensitive preferences provides a more comprehensive understanding of risk aversion, life-cycle behavior, and welfare under uncertainties. A quantitative analysis shows that IRA individuals accumulate more precautionary savings and adjust working hours to mitigate income shocks. However, this mitigation of uncertainty entails a cost of reduced resources, which could have otherwise been used to increase overall consumption of goods and leisures. Three alternative policies to address the challenges posed by aging are evaluated: increasing a payroll tax rate, reducing pension benefits, and extending the retirement age. The results show that individuals who expect to become more risk averse in old age may prefer the payroll tax rate increase, as the other two options results in relatively higher income uncertainty, which contradicts the results of previous studies that assumed constant risk aversion (CRA).