Risk Sharing and Asset Pricing under Alternative Retirement Systems
By Li Wei
We examine what happens to financial markets and how generations share risk when defined benefit (DB) pension plans are incorporated into an asset pricing model with imperfect markets. We look at how important it is for pension fund growth, changes in asset demand, and return-driven volatility channels to use an adjusted macroeconomic asset price model and past data on financial markets and the pension sector. We use scenario models to look at what would happen to the economy and people’s well-being if we switched from defined benefit (DB) plans to defined contribution (DC) plans. Our results indicate that adding DB pension funds makes it much easier for the model to match the risk-free rate and the past equity premium. The new steady state in DC plans has a higher risk-free rate and a lower equity price. Furthermore, retirees are more likely to have changes in their spending when their assets go up in value, while active workers are less likely to be affected by changes in the collective financing. These results have important policy effects. For example, countries that are switching to DC systems need to set up specific social safety nets and extra pension structures to protect seniors from more volatile markets while keeping their finances stable.
Source SSRN
