Optimal Risk Sharing in a Collective Defined Contribution Pension System

32 Pages Posted: 20 Apr 2016

See all articles by Dennis Bams

Dennis Bams

Maastricht University - Department of Finance; DLL

Peter C. Schotman

Maastricht University - Department of Finance

Mukul Tyagi

Maastricht School of Business and Economics

Date Written: March 20, 2016

Abstract

We analyze a collective defined contribution pension fund which aims at intergenerational risk sharing among different age cohorts using a return smoothing mechanism. Using a utility based framework, we find that approximately one third of unexpected return shocks should be directly passed on to all the cohorts in the year the shock occurs by means of the smoothing mechanism. We demonstrate that risk sharing implemented in this way is welfare improving compared to a plan with no risk sharing and more sustainable compared to defined benefit pension fund plans. Additionally, we show that the asset allocation of such a pension fund automatically corresponds to the life-cycle portfolio choice theory.

Keywords: Collective Defined Contribution, Funded Pension System, Overlapping Generations, Intergenerational Risk Sharing

JEL Classification: H55, G23, H80

Suggested Citation

Bams, Dennis and Schotman, Peter C. and Tyagi, Mukul, Optimal Risk Sharing in a Collective Defined Contribution Pension System (March 20, 2016). Netspar Discussion Paper No. 03/2016-015, Available at SSRN: https://ssrn.com/abstract=2766486 or http://dx.doi.org/10.2139/ssrn.2766486

Dennis Bams

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

DLL ( email )

Eindhoven
Netherlands

Peter C. Schotman

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

Mukul Tyagi (Contact Author)

Maastricht School of Business and Economics ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

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