Abstract

http://ssrn.com/abstract=2072323
 
 

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Generalized Fairness Preferences and Risk-Sharing Across Generations


Thomas Gilbert


University of Washington - Department of Finance and Business Economics

Christopher M. Hrdlicka


University of Washington - Michael G. Foster School of Business

February 4, 2014


Abstract:     
Leaders' preferences for fairness determine how they divide a stochastic surplus across generations and how much risk they take with this surplus. We generalize Rawlsian and utilitarian models of fairness preferences to a stochastic setting, nesting these previous models and separating the preferences for fairness across states and dates from those for risk aversion and intertemporal elasticity of substitution. This flexible parametrization allows us to model a wide range of preferences for fairness, which we apply to endowed funds (sovereign, non-profit, university), public pension plans, and the depletion of natural resources in the context of global warming. We find that a stronger preference for stochastic fairness generates lower risk taking and a lower but more stable growth path for the social surplus. Combined with the fact that a project's discount rate depends on its riskiness, our model rationalizes why leaders choose low discount rates when analyzing projects that span many generations. Indeed, it is their fairness-driven preferences that makes them choose safer projects, which, in turn, require the use of low discount rates. Similarly, fairness preferences explain why leaders act conservatively, e.g., in the case of climate policies, when imposing risk on others even though they, and their constituents, may have low risk aversion. Lastly, our model highlights a tension between the preference for intergenerational fairness and mandates for high payouts, e.g., in the case of public pension plans, to the current generation.

Number of Pages in PDF File: 62

Keywords: Fairness, intergenerational equity, risk-sharing, portfolio choice, endowments, public pension plans, global warming

JEL Classification: E61, D63, D78, H55, H43, Q32, Q56, G11

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Date posted: June 2, 2012 ; Last revised: February 5, 2014

Suggested Citation

Gilbert, Thomas and Hrdlicka, Christopher M., Generalized Fairness Preferences and Risk-Sharing Across Generations (February 4, 2014). Available at SSRN: http://ssrn.com/abstract=2072323 or http://dx.doi.org/10.2139/ssrn.2072323

Contact Information

Thomas Gilbert (Contact Author)
University of Washington - Department of Finance and Business Economics ( email )
Box 353200
Seattle, WA 98195
United States
206-616-7184 (Phone)
HOME PAGE: http://faculty.washington.edu/gilbertt/
Christopher M. Hrdlicka
University of Washington - Michael G. Foster School of Business ( email )
Box 353200
Seattle, WA 98195
United States
206.616.0332 (Phone)
206.542.7472 (Fax)
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