Social Security in an Analytically Tractable Overlapping Generations Model with Aggregate and Idiosyncratic Risk

SAFE Working Paper No. 71

35 Pages Posted: 29 Oct 2014 Last revised: 16 Apr 2015

See all articles by Daniel Harenberg

Daniel Harenberg

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich; Oxford Economics

Alexander Ludwig

Leibniz Institute for Financial Research SAFE; University of Cologne - Faculty of Management, Economics and Social Sciences

Multiple version iconThere are 3 versions of this paper

Date Written: April 13, 2015

Abstract

When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations. We derive the equilibrium dynamics in closed form and show that joint presence of both risks leads to over-proportional risk exposure for households. This implies that the whole benefit from insurance through social security is greater than the sum of the benefits from insurance against each of the two risks in isolation. We measure this through interaction effects which appear even though the two risks are orthogonal by construction. While the interactions unambiguously increase the welfare benefits from insurance, they can in- or decrease the welfare costs from crowding out of capital formation. The net effect depends on the relative strengths of the opposing forces.

Keywords: social security, idiosyncratic risk, aggregate risk, welfare, insurance, crowding out

JEL Classification: C68, E27, E62, G12, H55

Suggested Citation

Harenberg, Daniel and Ludwig, Alexander, Social Security in an Analytically Tractable Overlapping Generations Model with Aggregate and Idiosyncratic Risk (April 13, 2015). SAFE Working Paper No. 71. Available at SSRN: https://ssrn.com/abstract=2515696 or http://dx.doi.org/10.2139/ssrn.2515696

Daniel Harenberg

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Oxford Economics ( email )

United Kingdom

Alexander Ludwig (Contact Author)

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

University of Cologne - Faculty of Management, Economics and Social Sciences ( email )

Albertus-Magnus-Platz
Cologne, D-50923
Germany

HOME PAGE: http://www.wiso.uni-koeln.de/cmr/alexludwig

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