Can Internal Swap Markets Enhance Welfare in Defined Contribution Plans?

Abstract

There is a worldwide trend to substitute defined contribution pension plans for defined benefit plans, which are typically indexed to wage or price inflation. A problem with this development is that participants in defined contribution plans have limited access or no access at all to inflation-linked assets, especially wage inflation-linked claims. This article demonstrates that the creation of an internal market that swaps equity-related returns for wage inflation-linked income streams helps to overcome the market incompleteness regarding wage-linked securities. The result is an improvement in the welfare of both younger and older defined contribution plan members.

Keywords: Defined Contribution Plan, Internal Swap Market, Life-Cycle Theory, Pension Fund, Wage