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Default Behavior and Risk Aversion in Defined Contribution Retirement Systems: Evidence from Chile
Abstract
This paper studies the design of investment policies in defined contribution retirement systems. I estimate a dynamic system of correlated equations of lifecycle behavior that fully models the individual’s decision-making process to account for estimation biases. In the model, individuals make decisions that impact their retirement wealth within the Chilean retirement system. Behaviors are allowed to depend on risk preferences while modeling other sources of nonlinear unobserved heterogeneity. The estimated decision-making process allows us to simulate the effects of policy experiments (ex ante), such as defaulting individuals into riskier investment strategies or increasing contribution rates. The results indicate that individuals react by opting into safer plans despite their observed inertia and that increases in mandatory contributions generate little crowding out of other behaviors. Not modeling risk aversion and its endogeneity with behavior leads to substantial simulation biases.
... The Chilean withdrawals represented a total rundown in pension assets of around 20% of the GDP and reduced the contributory pensions of almost 11 million workers (Evans and Pienknagura, 2021;Fuentes et al., 2021Fuentes et al., , 2023. Therefore, the economic implications of the Chilean withdrawals are significant for the future retirees, especially as the current low level of contributory pension savings may increase the demands for pension reform (Evans and Pienknagura, 2021;Parada-Contzen, 2022;Madeira, 2022a), while reducing domestic savings and investment (Cerda et al., 2020;Parada-Contzen, 2020;Madeira, 2022a). ...
This paper studies crowd-out effects across choices regarding different sources of investment and savings in the Chilean pension system (e.g., voluntary savings within and outside the retirement system, housing status, and default portfolio adoption). Because preferences over choice sets are unobserved and it is expected that individual unobserved characteristics may be correlated across decisions, I jointly estimate a dynamic reduced-form life cycle model of wealth accumulation. Simulation results indicate no short- or long-run crowd-out effects across voluntary savings accounts within and outside the retirement system. There is evidence that in the short run, there is crowding-out between mandatory savings and other forms of investments, such as home ownership or savings in the financial-banking sector. Results also show that in the long run, individuals treat home ownership and participation in voluntary retirement programs as substitute goods. Finally, the long-run effects of participating in voluntary savings programs are important in increasing active participation in portfolio decisions.
We present a semiparametric method to estimate group-level dispersion, which is particularly effective in the presence of censored data. We apply this procedure to obtain measures of occupation-specific wage dispersion using top-coded administrative wage data from the German IAB Employment Sample. We then relate these robust measures of earnings risk to the risk attitudes of individuals working in these occupations. We find that willingness to take risk is positively correlated with the wage dispersion of an individual’s occupation.
This paper studies crowd-out effects across choices regarding different sources of investment and savings in the Chilean pension system (e.g., voluntary savings within and outside the retirement system, housing status, and default portfolio adoption). Because preferences over choice sets are unobserved and it is expected that individual unobserved characteristics may be correlated across decisions, I jointly estimate a dynamic reduced-form life cycle model of wealth accumulation. Simulation results indicate no short- or long-run crowd-out effects across voluntary savings accounts within and outside the retirement system. There is evidence that in the short run, there is crowding-out between mandatory savings and other forms of investments, such as home ownership or savings in the financial-banking sector. Results also show that in the long run, individuals treat home ownership and participation in voluntary retirement programs as substitute goods. Finally, the long-run effects of participating in voluntary savings programs are important in increasing active participation in portfolio decisions.
We examine the investment performance of Chilean pension funds during their multi-fund period (2003–17). Using tradable asset class benchmarks, we extend Sharpe's (1992) return-based style analysis by explicitly considering regulatory restrictions and currency hedging. We find that despite the significant differences between pension fund manager returns, they are statistically similar to our style benchmarks for all fund types. Furthermore, accounting for currency hedging improves the accuracy of the replicating portfolios and the selection return estimates. Our results have policy implications for investment regulation of pension systems with similar characteristics to the Chilean one.
Exploiting portfolio data and repeated surveys of an Italian bank's clients, we test whether investors’ risk aversion increases following the 2008 crisis. We find that, after the crisis, both qualitative and quantitative measures of risk aversion increase substantially and that affected individuals divest more stock. We investigate four explanations: changes in wealth, expected income, perceived probabilities, and emotion-based changes of the utility function. Our data are inconsistent with the first two channels, while they suggest that fear is a potential mechanism underlying financial decisions, whether by increasing the curvature of the utility function or the salience of negative outcomes.
Research on decision-making strategies among younger and older adults suggests that older adults may be more risk averse than younger people in the case of potential losses. These results mostly come from experimental studies involving gambling paradigms. Since these paradigms involve substantial demands on memory and learning, differences in risk aversion or other features of decision-making attributed to age may in fact reflect age-related declines in cognitive abilities. In the current study, older and younger adults completed a simpler, paired lottery choice task used in the experimental economics literature to elicit risk aversion. A similar approach was used to elicit participants' discount rates. The older adult group was more risk averse than younger adults (p < .05) and also had a higher discount rate (15.6-21.0% vs. 10.3-15.5%, p < .01), indicating lower expected utility from future income. Risk aversion and implied discount rates were weakly correlated. It may be valuable to investigate developmental changes in neural correlates of decision-making across the lifespan.
Many studies show that women are more risk averse than men. In this paper, following DeLeire and Levy [Deleire T. and Levy H. (2004) ‘Worker Sorting and the Risk of Death on the Job’, Journal of Labor Economics, Vol. 22, No. 4, pp. 210–217.] for the US, we use family structure as a proxy for the degree of risk aversion to test the proposition that those with strong aversion to risk will make occupational choices biased towards safer jobs. In line with DeLeire and Levy we find that women are more risk averse than men and those that are single with children are more risk averse than those without. The effect on the degree of gender segregation is somewhat smaller than for the US.
Competition across money managers, along with market entry, in theory could ensure that capital market remains competitive. But in Chile, which has had a privatized pension system for 25 years, high rates of switching between the funds and little downward movement on fees, have been interpreted as evidence of market inefficiency. This chapter uses a change in the regulatory rules governing the marketing of AFP pensions (Administradoras de Fondos de Pensiones) in Chile to investigate the empirical basis for sources of market frictions. We find that switching patterns are on a par with trading in US 401(k) accounts, and further, that switchers tend to be highly educated and relatively more highly paid. Switching is also more common among those with higher levels of financial literacy. The 1997 regulatory change appears to have reduced switching, particularly among the better educated.
The wide range of 401(k) plans offered to employees has raised the question of whether there is such as thing as too much choice. The 401(k) participation rates among clients of the Vanguard Group were studied to verify the assumption that more choice is more desirable and intrinsically motivating. It was found that 401(k) plans that offered more funds had lower probability of employee participation. © Pension Research Council, The Wharton School, University of Pennsylvania, 2004. All rights reserved.
This paper quantifies the impact of life‐cycle events on retirement wealth. Because lifetime events impact through multiple channels, I estimate a set of correlated equations that capture labor market behavior, portfolio and savings decisions, risk preferences, family and health characteristics, using data from the iconic Chilean experiment. Results indicate that gender inequality due to marital status is responsible for 18 dollars of wealth differences per married year. Impacts on wealth accumulation from childbearing range between 9 and 114 dollars per child per year. Health shocks have an impact of 39 dollars per year on retirement wealth.
We model the observed smoking outcomes of an individual and her social contact - a spouse, friend, sibling, parent or adult child - as a simultaneous move game with complete information. We allow an individual’s smoking behavior to depend on her previous behavior and carefully account for observed and unobserved heterogeneity. Our econometric model addresses simultaneity, homophily, health endogeneity, non-random attrition, and multiplicity of equilibria together. Using network data from the Framingham Heart Study, we find smaller social interaction effects among spouses and friends than Christakis and Fowler (2008) who pioneered such exploration with these data. We also find that social interaction impacts of the endogenous behaviors of siblings or a parent and an adult child are not statistically significant after disentangling them from homophily. In addition, we find that the effects of social contacts’ cardiovascular disease shocks on individual smoking behavior are not statistically significant.
Using a combination of survey data plus the demographic and life expectancy projections for Chile I simulate how different policies may impact the workers’ pensions and voluntary savings. I find that households dissave from their public pension benefits, but not from their contributory pensions, therefore policy increases of contributions are not crowded-out by private decisions. The results show that an increase of the contribution rate plus a delay of the retirement age is necessary to achieve high replacement ratios until 2055. Boosting the education of younger generations and incentives for female employment is efficient for increasing pensions among the poorest households.
In January 2006, the Dutch government implemented a pension reform that substantially reduced the public pension wealth of workers born in 1950 or later. At the same time, a tax-facilitated savings plan
was introduced that implied a large savings subsidy for all workers, irrespective of birth year. This paper uses linked administrative and survey data to assess the effect of the reform on the savings and retirement expectations and realizations of two virtually identical male cohorts that differ only in treatment status, the treated having been born in 1950 and the controls having been born in 1949. We show that
retirement expectations are in line with realizations and that the reform increased the labor supply for the larger part of the workers, namely, those without sufficient means to substantially increase private savings to counter the effect of the reform. These workers have zero substitution rates between private and public wealth. On the other hand, there is a group of mostly high-wage workers who participate in the tax-facilitated savings plan and increase their private savings to fully counter the impact of the drop in public wealth. An unintended side effect of the introduction of the tax-facilitated savings plan is that high-wage earners who are not affected by the drop in pension wealth retire even sooner than initially planned.
As populations age, countries across the globe are dealing with the issue of how to fund retirement consumption for their workers. The design of Social Security programs is more difficult when the country also exhibits an informal economy where workers avoid the taxation of the government and are not entitled to its benefits. In this paper, I study the example of Chile–a country that transitioned from a pay-as-you-go Social Security system to a system of private, individual retirement accounts in 1981 and also exhibits a significant informal sector–in order to quantify the transitional welfare impact of Social Security privatization when workers have the option to evade the public system through informality. I construct an OLG model which allows households to split working time between a taxed formal sector, an untaxed informal sector, and home production. I find large long-run welfare gains of roughly 10 and 15 percent for low and high-productivity workers, respectively. However, these gains come at the expense of losses for two groups: low-productivity workers who are retired at the time of the reform and high-productivity workers within 5 years of retirement at the time of the reform. The presence of informality leads to conflicting mechanisms: (1) the elasticity channel decreases welfare gains from reform: including informality as imperfectly substitutable with formality in utility decreases labor supply elasticity and renders the pay-as-you-go payroll tax less distortionary, and (2) the market wage channel increases welfare gains from reform: the privatization of the Social Security system causes wage growth which informal workers can receive without facing the distortions of any remaining taxation in the formal sector. Quantitative results indicate the elasticity channel is stronger in the case of Chile, and the inclusion of informality decreases the long-run welfare gains from privatizing Social Security.
Deciding how much to save for retirement can be complicated. Drawing on a field experiment conducted with the Department of Defense, we study whether such complexity depresses participation in an employer-sponsored retirement saving plan. We find that simplifying one dimension of the enrollment decision, by highlighting a potential rate at which non-participants might contribute, increases participation in the plan. Similar communications that did not include a highlighted rate yield smaller effects. The results highlight how reducing complexity on the intensive margin of a decision (how much to contribute) can affect extensive margin behavior (whether to contribute at all) in a setting of policy interest.
Defined contribution (DC) pension plans have been gaining ground in the last 10–20 years as the preferred system for many countries and other agencies, both private and public. The central question for a DC plan is how to invest in order to reach the participant's retirement goals. Given the financial illiteracy of the general population, it is common to offer a default policy for members who do not actively make investment choices. Using data from the Chilean system, we discuss an investment model with fixed contribution rates and compare the results with the existing default policy under multiple objectives. Our results indicate that the Chilean default policy has good overall performance, but specific closed-loop policies have a higher probability of achieving desired retirement goals and can reduce the expected shortfall at retirement.
Using tax data, this paper exploits a discontinuous increase in retirement contribution limits based on exact date of birth. This paper finds clear evidence that constrained individuals increase their retirement saving when so eligible, but finds no evidence suggesting that non-retirement saving falls. In the baseline specifications, one can rule out crowd-out greater than approximately 0.38 to 0.57 at the 95% confidence level depending on the measure used. This suggests that the additional contributions induced by catch-up eligibility represent an increase in total private saving.
We study the effects of different pricing schemes on the overall surplus in a privately managed retirement system with multiple service providers and switching costs. We develop a theoretical model based on the Chilean retirement system and consider a repeated auction for monopoly rights over new enrollees. We consider a dynamic model solved by pension fund administrators and by consumers. We compare three different pricing schemes: (a) fees on contributions, (b) fees on returns, and (c) a two‐part tariff including an auction over a guaranteed rate of return and allowing the firm to keep a portion of returns generated above this guaranteed rate. We also consider heterogeneity across individuals where agents earn high or low wages and high‐wage customers have proportionally lower switching costs due to more cost‐effective access to financial planning services. We find that auction participants subsidize consumers. We also treat savings as a durable good. In this case, pricing over returns worsens the switching related inefficiencies just described relative to pricing over contributions, despite the better incentives it provides. These inefficiencies can be resolved by allowing firms to price discriminate.
How do different switching costs affect choices and competition in a private pension system? I answer this question in a setting in which variation in employment status allows me to identify two switching costs that jointly affect enrollees’ decisions: the cost of evaluating financial information and the cost of the bureaucratic process that enrollees must navigate when switching. I use this variation to estimate the different switching costs and study their impact on competition among pension funds. I find that though eliminating all switching costs decreases equilibrium fees the most, eliminating either switching cost decreases fees significantly. JEL (D14, G23, J26, J32, O15)
We document a novel channel through which coordinated trading exerts externalities on financial markets. We study the impact of a financial advisory firm that recommends frequent reallocations between equity and bond funds to Chilean pension investors. The recommendations generate large and coordinated fund flows that are exacerbated by the strategic complementarity arising from fund trading restrictions. The recommendations generate significant price pressure and increased volatility in the stock market. In response to these large trade flows, pension funds shift their allocations to more liquid securities. Our findings suggest that giving retirement savers unconstrained reallocation opportunities can destabilize financial markets.
Received March 11, 2016; editorial decision July 8, 2017 by Editor Itay Goldstein.
Chile's individual retirement pension accounts system has been a model for many countries. To limit the riskiness of pension investments, Chile required pension fund managers to deliver returns that are not more than two percent below the industry average. We develop and estimate a model of the pension investment market which allows us to study the impact of minimum return regulation. We find that the regulation leads to higher demand for risky investments, creates incentives to offer riskier portfolios and leads to higher management fees. However, the regulation also stimulates balance accumulation which ultimately reduces the reliance on government support.
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How can retirement savings be increased? We explore a unique policy change in the context of the German pension system to study this question. As of 2005 (with a phase-in period between 2002–04), the German pension administration started to send out annual letters providing detailed and comprehensible information about the pension system and individual expected public pension payments. This reform did not change the level of pensions, but only provided information to individuals about their expected pension payments. Using German tax return data, we exploit an age discontinuity to identify the effect of these letters on the behavior of individuals. We find an increase in tax-deductible private retirement savings and provide evidence that this is not due to a crowding-out of other forms of savings. We also show that labor earnings, i.e. the most direct way to increase public pensions, increase after receiving the letter.
We quantify the life-cycle effects of human and health capital on the wage distribution of women, with a focus on health capital measured by body mass. We use NLSY79 data on women followed annually up to twenty years during the time of their lives when average annual weight gain is greatest. We measure the wage impact of current body mass (i.e., the contemporaneous or direct effect) while controlling for observed measures of human capital (namely, educational attainment, employment experience, marital status tenure, and family size) and the impacts of an evolving body mass (i.e., the dynamic or indirect effects) on the endogenous histories of behaviors that produce these human capital stocks. We find significant differences in the contemporaneous and dynamic effects of body mass on wages by age, by race, and by wage level.
We empirically assess whether a health shock influences individual risk aversion. We use grip strength data to obtain an objective health shock indicator. In order to account for the non-random nature of our data regression-adjusted matching is employed. Risk preferences are traditionally assumed to be constant. However, we find that a health shock increases individual risk aversion. The finding is robust to a series of sensitivity analyses and persists for at least four years after the shock. Income changes do not seem to be the driving mechanism.
We estimate a structural dynamic model of the determinants of obesity. In addition to including many of the well-recognized endogenous factors mentioned in the literature as obesity determinants, we also model the individual's residential location as a choice variable, which is the main contribution of this paper to the literature. This allows us to control for an individual's self-selection into communities that possess the types of amenities in the built environment, which in turn affect their obesity-related behaviors such as physical activity (PA) and fast food consumption. We specify reduced form equations for a set of endogenous demand decisions, together with an obesity structural equation. The whole system of equations is jointly estimated by a semi-parametric full information log-likelihood method that allows for a general pattern of correlation in the errors across equations. Our model predicts a reduction in adult obesity of 7 percentage points as a result of a continued high level PA from adolescence into adulthood; a reduction of 0.7 (3) percentage points in adult obesity as a result of one standard deviation reduction in weekly fast food consumption for women (men); and a reduction of 0.02 (0.05) in adult obesity as a result of one standard deviation change in several neighborhood amenities for women (men). Another key finding is that controlling for residential self-selection has substantive implications. To our knowledge, this has not been yet documented within a full information maximum likelihood framework.
We use the panel data of the German Socio-Economic Panel (SOEP) and of the Ukrainian Longitudinal Monitoring Survey (ULMS) to investigate whether risk attitudes have primary (exogenous) determinants that are valid in different stages of economic development and in a different structural context, comparing a mature capitalist economy and a transition economy. We then analyze the stability of the risk measures over time. Between 2007 and 2012 we have the Great Recession, which had a mild impact in the German labor market while it had a more profound impact on the Ukrainian labor market. This enables us to investigate whether and how the crisis impacted on the risk attitudes in the two countries. By focusing on self-employment we also investigate whether the reduced willingness to take risks as a consequence of the Great Recession affects labor market dynamics and outcomes
Determination of evidence-based best practice guidelines and evaluation of medical and nonmedical determinants of health requires modeling of consumer demand as well as health production. Toward this end, we examine the impact of endogenous health insurance coverage, which creates variation in the prices of medical care across individuals as well as a change in the relative price of nonmedical health inputs. Specifically, we analyze the decisions of individuals with diabetes to monitor, treat, and manage their condition and their subsequent health outcomes. Diabetics can experience serious or fatal complications without regular monitoring (of blood glucose and other indicators of disease severity) and, in some cases, prescription medication. These activities can present a significant financial burden that could be substantially attenuated by health insurance. Through cross-price effects, insurance may also influence important nonmedical input choices such as exercise and diet. Using a sample of nonelderly diabetics from the Medical Expenditure Panel Survey, we jointly estimate demand equations for health insurance, medical treatment, lifestyle decisions, and health, controlling for their common unobserved determinants. We find that insurance with drug coverage leads to better adherence to diabetic care guidelines. There is, however, some evidence of ex ante moral hazard: those covered by insurance with a drug plan show slightly lower probabilities of exercising regularly.
This article investigates the fiscal and welfare trade-offs involved in designing a pension system when workers can avoid contributing by working informally. Using a life-cycle model of labor supply and saving decisions, I structurally estimate preferences and earnings opportunities in the formal and informal sectors using data on Chilean households. I find limited support for formal jobs rationing. Instead, mandatory pension contributions significantly encourage informality. Policy experiments show that Chile could lower minimum pension spending by 23%—while guaranteeing the same income to retirees—if the minimum pension's implicit tax rate was increased to 60%.
This study investigates whether and how the crisis in 2008/2009 affects households’ risk attitudes, subjective risk and return expectations, and planned financial risk taking using the German SAVE study. Households’ wealth change from end-2007 to end-2009 is not found to have an effect. However, households that attribute losses to the crisis decreased their risk tolerance and planned risk taking; the probability of expecting an increase in risks and returns is increased. According to economic theory, wealth changes attributed to a dramatic event should not have a different effect than other wealth changes. The results suggest an emotional reaction.
Using 41 million observations on savings for the population of Denmark, we show that the effects of retirement savings policies on wealth accumulation depend on whether they change savings rates by active or passive choice. Subsidies for retirement accounts, which rely on individuals to take an action to raise savings, primarily induce individuals to shift assets from taxable accounts to retirement accounts. We estimate that each $1 of government expenditure on subsidies increases total saving by only 1 cent. In contrast, policies that raise retirement contributions if individuals take no action-such as automatic employer contributions to retirement accounts-increase wealth accumulation substantially. We estimate that approximately 15% of individuals are "active savers" who respond to tax subsidies primarily by shifting assets across accounts; 85% of individuals are "passive savers" who are unresponsive to subsidies but are instead heavily influenced by automatic contributions made on their behalf. Active savers tend to be wealthier and more financially sophisticated. We conclude that automatic contributions are more effective at increasing savings rates than subsidies for three reasons: (i) subsidies induce relatively few individuals to respond, (ii) they generate substantial crowd-out conditional on response, and (iii) they do not increase the savings of passive individuals, who are least prepared for retirement.
This study examined the investment decisions of women and men in Chile who were contributing to Chile’s mandatory defined contribution (DC) retirement plan, using a large survey of participants (2782 people) conducted in 2009 by Chile’s Subsecretariat of Social Protection. The basic research question was whether Chilean women were more risk averse in their retirement investment decisions than Chilean men. Chile’s retirement plan offers a default plan for those who do not want to manage their funds. For those wishing to manage their investments, it offers five funds varying in risk from an all bond fund to a fund that is primarily stocks. There was no significant difference in the percentage of men and women choosing the default funds. We used probit analysis to determine what demographic factors affected the choice of the default fund, and found that younger people and men with less education and less income were more likely to choose the default; only age was significant for women. We found no significant gender differences in the fund choices of active investors. We conducted linear regression analysis by gender, where the dependent variable was the fund, with fund 1 having the lowest risk and fund 5 having the highest risk. We found that that the risk taking decreased with age and increased with financial knowledge, psychological risk tolerance, income and unemployment. Chilean women and men seemed similar in their investment decisions.
This paper contributes to research on defined contribution (DC) retirement plans by examining how financial knowledge and demographic factors influenced Chile's pension holders' choice between a default life-cycle retirement plan and active management. About one third of Chileans held default funds in 2009; younger people, men, people with lower incomes, and people with low financial knowledge were more likely to choose the default. For active investors, we examined what variables influenced their choice. Nearly three quarters of active investors chose more risky funds that the defaults for their age group. However, risk taking tended to decrease with age and to increase with income, financial knowledge and risk tolerance.
We use a dynamic modeling strategy to evaluate two potential avenues through which health differences generate a wage gap: directly through reductions in health capital and indirectly through employment transitions that reduce human capital (specifically, occupation and employer tenure). Our results suggest that male workers with a moderate disability are 23 percent more likely to change occupations or employers than nondisabled men. Compared to those who do not make a transition, workers with a moderate disability who change occupations and employers experience an immediate 0.57 decline associated with the disability onset.
Most classical tests of constant relative risk aversion (CRRA) based on individual portfolio
composition use cross-sectional data. Such tests must assume that the distributions of wealth and
preferences are independent. We use panel data to analyze how individuals’ portfolio allocation
between risky and riskless assets varies in response to changes in total financial wealth. We find the
elasticity of the risky asset share to wealth to be small and statistically insignificant, supporting the
CRRA assumption; this finding is robust when the sample is restricted to households experiencing
large income variations. In addition, we find a small but significant negative correlation between
wealth and risk aversion. Various extensions are discussed.
A frequent challenge in program impact estimation, and causal modeling more generally, is estimation of the effect of a binary endogenous variable on a binary outcome of interest. We report results from Monte Carlo experiments designed to assess the performance of estimators frequently applied in this circumstance. Many rely on an instrumental variables identification strategy and in those instances our central interest is the overidentified case. Even when identification is technically achieved by functional form, it is widely perceived that instruments generate more credible identification. Our focus is on widely used models available in the popular STATA statistical software package, but we also evaluate a semi-parametric instrumental variables random effects model not yet available in STATA. The parameters of interest in these experiments are program impact, test statistics assessing endogeneity and overidentification tests. We consider performance under alternative behavioral circumstances by varying distributional assumptions for unobservables, instrument strength levels, sample sizes, and impact magnitudes. Some models turn in a somewhat disappointing performance. Those that rely on joint normality for identification are not particularly robust to error misspecification, raising questions about whether they should be preferred to the semi-parametric estimator (regardless of comparative ease of estimation) or even to simple single equation models that ignore endogeneity. We provide examples of the methods using data from Bangladesh and Tanzania.
In a defined contribution pension system, one of the main risks faced by members refers to the investment of funds. In this context, we discuss which is the most suitable risk measurement for the affiliates to the pension system. Different life-cycle investment strategies are evaluated under this measure for different types of workers. We point out the importance of designing well-suited default investment options in light of the economic behavior of members, characterized by low financial knowledge, inertia and myopia in decision-making. We calibrate a pension risk model for the Chilean economy, including measures of life-cycle income, human capital risk, investment and annuitization risks. Our results suggest that affiliates can gain (loss) around 0.85 percentage points in terms of average replacement rates in return for an increase (decrease) of 1 percentage point in risk, measured as standard deviation of replacement rates. Using a stochastic dominance analysis, we find that there are no dominated strategies when subsidies from the Solidarity Pillar are excluded. When the Solidarity Pillar is considered, the most appropriate investment strategies for affiliates that receive these subsidies are concentrated on the riskier funds. However, this also means that there could be increased pressure on Government spending in order to grant additional benefits to affiliates. Our model has a wide range of practical applications that go from informing affiliates about the degree of uncertainty associated to their expected replacement rate to a guide to evaluate how different investment strategies affect the expected values of affiliates' pensions and their associated risk.
This paper examines how advertising impacts competition and equilibrium prices in the context of a privatized pension market. We use detailed administrative data on fund manager choices and worker characteristics at the inception of Mexico’s privatized social security system, where fund managers had to set prices (management fees) at the national level, but could select sales force levels by local geographic areas. We develop a model of fund manager choice, price and advertising competition (in terms of sales force deployment), nesting models of informative and persuasive advertising. We find evidence in favor of the persuasive view; exposure to sales force lowered price sensitivity and increased brand loyalty, leading to inelastic demand and high equilibrium fees. We simulate oft-proposed policy solutions: a supply-side policy with a competitive government player, and a demand-side policy which increases price elasticity. We find that demand-side policies are necessary to foster competition in social-safety-net markets with large segments of inelastic consumers.
Stability of preferences is central to how economists study behavior. This paper uses panel data on hypothetical gambles over lifetime income in the Health and Retirement Study to quantify changes in risk tolerance over time and differences across individuals. The maximum-likelihood estimation of a correlated random effects model utilizes information from 12,000 respondents in the 1992-2002 HRS. The results are consistent with constant relative risk aversion and career selection based on preferences. While risk tolerance changes with age and macroeconomic conditions, persistent differences across individuals account for 73% of the systematic variation.
Do retirement savings policies – such as tax subsidies or employer-provided pension plans – increase total saving for retirement or simply induce shifting across accounts? We revisit this classic question using 45 million observations on wealth for the population of Denmark. We find that a policy's impact on wealth accumulation depends on whether it changes savings rates by active or passive choice. Tax subsidies, which rely upon individuals to take an action to raise savings, have small impacts on total wealth. We estimate that each $1 of tax expenditure on subsidies increases total saving by 1 cent. In contrast, policies that raise retirement contributions if individuals take no action – such as automatic employer contributions to retirement accounts – increase wealth accumulation substantially. Price subsidies only affect the behavior of active savers who respond to incentives, whereas automatic contributions increase the savings of passive individuals who do not reoptimize. We estimate that approximately 85% of individuals are passive savers. The 15% of active savers who respond to price subsidies do so primarily by shifting assets across accounts rather than reducing consumption. These individuals are also more likely to offset changes in automatic contributions and have higher wealth-income ratios. We conclude that automatic contributions are more effective at increasing savings rates than price subsidies for three reasons: (1) subsidies induce relatively few individuals to respond, (2) they generate substantial crowd-out conditional on response, and (3) they do not influence the savings behavior of passive individuals, who are least prepared for retirement.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Most defined-contribution (DC) pension plans give members a degree of choice as to the investment strategy for their contributions. For members unable or unwilling to choose their own investment strategies, many plans also offer a default fund. This article analyzes the U.K. "stakeholder" DC plans, which must by law offer a default fund. The default funds are typically risky but vary substantially among the providers in their strategic asset allocation and in their use of life-cycle plans that reduce risk as planned retirement approaches. A stochastic simulation model demonstrates that the differences can have a significant effect on the distribution of potential pension outcomes.
This article uses life insurance data to estimate the Pratt-Arrow coefficient of relative risk aversion for each of nearly 2,400 households. Attitudinal differences toward pure risk are then examined across demographic sub- groups. Additionally, differences in speculative risk-taking are examined across demographic groups based on survey responses and compared with the results on pure risk aversion.