Intergenerational Risk Sharing under Loss Averse Preferences

31 Pages Posted: 23 Mar 2014 Last revised: 26 Sep 2016

See all articles by Mark-Jan Boes

Mark-Jan Boes

VU University Amsterdam

Arjen Siegmann

VU University Amsterdam

Date Written: July 29, 2016

Abstract

Individual retirement savings schemes could benefit from risk-sharing mechanisms between generations that take behavioral aspects into account. We introduce a novel risk-sharing mechanism that incorporates nominal loss-aversion in two ways. First, the system avoids out-of-pocket wealth transfers by sharing only a fraction of positive returns over a high-water mark of pension assets. Secondly, payments from a generation insurance fund are targeted at nominal pension shortfalls below a reference point, which mitigates the loss experience at retirement. From a simulation of overlapping generations with stochastic asset returns and interest rates we find that the generation insurance scheme outperforms a pure individual retirement scheme by a significant margin: a similar risk of pension shortfall can be achieved with a contribution rate that is up to 20% lower. The efficiency gains vary with the extent of risk sharing over generations but remain large for sensible parameter values.

Keywords: retirement saving, loss aversion, risk sharing, insurance, collective defined-contribution (CDC)

JEL Classification: B22, J26, G23, H55

Suggested Citation

Boes, Mark-Jan and Siegmann, Arjen, Intergenerational Risk Sharing under Loss Averse Preferences (July 29, 2016). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2412617 or http://dx.doi.org/10.2139/ssrn.2412617

Mark-Jan Boes

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Arjen Siegmann (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Dept. of Finance
Amsterdam, NOT IN US OR CANADA 1081 HV
Netherlands
+31205986581 (Phone)

HOME PAGE: http://personal.vu.nl/a.h.siegmann

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