Funded Pensions and Intergenerational and International Risk Sharing in General Equilibrium

Abstract

We explore intergenerational and international risk sharing in a general equilibrium multiple-country model with two-tier pensions systems. The exact design of the funded tier is key for the way in which risks are shared over the various generations. The laissez-faire market solution fails to provide an optimal allocation because the young cannot share in the risks. However, the existence of wage-indexed bonds combined with a pension system with a fully-funded second tier that pays defined wage-indexed benefits can reproduce the first best. If wage-indexed bonds are not available, mimicking the first best is not possible, except under special circumstances. We also explore whether national pension funds want to deviate from the first best by increasing domestic equity holdings. With wage-indexed bonds this incentive is absent, while there is indeed such an incentive when wage-indexed bonds do not exist.

Keywords: defined wage-indexed benefits, funded pensions, overlapping generations, risk sharing, wage-indexed bonds

JEL Classification: E2, F42, G23, H55