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OPTIMAL MIX BETWEEN PAY AS YOU GO AND FUNDING FOR PENSION LIABILITIES IN A STOCHASTIC FRAMEWORK

Published online by Cambridge University Press:  14 August 2015

Pierre Devolder  and
Roberta Melis
Pierre Devolder
Affiliation:
Institute of Statistic, Biostatistic and Actuarial Science (ISBA), Université Catholique de Louvain (UCL), 20 Voie du Roman Pays, 1348 Louvain la Neuve, Belgium E-Mail: [email protected]
Roberta Melis
Affiliation:
Department of Economics, Universitas Mercatorum, via Appia Pignatelli 62, 00178 Roma, Italy E-Mail: [email protected] and CRENoS Centre for North South Economic Research
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Abstract

This paper addresses the financing of public pensions in a stochastic environment. Traditionally, funded and unfunded pension schemes have been viewed as opposite solutions for the first pillar of public pensions. However, more recently countries as Sweden and Poland have explored mixed solutions that combine pay-as-you-go (PAYG) with funding mechanisms. The aims of this paper are to examine the rationality of such a combination using portfolio theory arguments and to find the optimal split of the contributions between the two systems. We first introduce the classical deterministic model leading to the well-known Samuelson–Aaron rule according to which diversification is never optimal. We then introduce different stochastic models in which the main processes (wage growth, population growth, financial rate of return) are random. In particular, we obtain conditions on parameters to justify diversification and explicit optimal sharing between PAYG and funding. We also introduce the possibility of investing in several financial assets and explore the impact of introducing systematic longevity risk.

Keywords

Pay as you gofundingdiversificationportfolio theory
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 45 , Issue 3 , September 2015 , pp. 551 - 575
Copyright
Copyright © Astin Bulletin 2015 

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