A Portfolio Approach to the Optimal Mix of Paygo and Funded Pension Systems
30 Pages Posted: 22 May 2010 Last revised: 3 Oct 2011
Date Written: April 29, 2011
We analyze the rationale for the pay-as-you-go (paygo) pension system existence on diversi fication grounds. A continuous-time portfolio choice setting is built, basing on Merton (1971)´s analysis, where a reasonable balance between the taking account of the economic and fi nancial facets of the problem is sought. The optimal portfolio rule is derived, following the usual objectives of speculation and hedging. The existing literature provided some intuitions as to the primordial, and non-evident, role played by the correlation between the stock market and wages for the optimal paygo weight. This paper focuses on this role and derives two analytical results involving the described correlation: the condition for the paygo system usefulness and the one defi ning the correlation effect direction on the optimal paygo magnitude.
Keywords: social security, unfunded and funded pension systems, optimal portfolio, diversifi cation, stochastic dynamic programming
JEL Classification: C61, G11, G23, H55
Suggested Citation: Suggested Citation