Intergenerational Risk Sharing with Market Liquidity Risk
Tinbergen Institute Discussion Paper 2022-028/V
47 Pages Posted: 27 Apr 2022
Date Written: March 30, 2022
Abstract
This paper examines the optimal allocation of risk across generations whose savings mix is subject to illiquidity in the form of uncertain trading costs. We use a stylized two-period OLG framework, where each generation makes a portfolio allocation decision for retirement, and show that illiquidity reduces the range of transferable shocks between generations and thus lowers the benefits of risk-sharing. Higher illiquidity then may justify higher levels of risk sharing to compensate for the trading friction. We still find that a contingent transfers policy based on a reasonably parametrized savings portfolio with liquid and illiquid assets increases aggregate welfare.
Keywords: intergenerational risk sharing, (il)liquidity, stochastic overlapping generations, funded pension plan
JEL Classification: G11,G23,E21,H55
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