Unhedgeable inflation risk within pension schemes

D.H.J. Chen, Roel Beetsma and Sweder van Wijnbergen

Insurance: Mathematics and Economics, 2020, vol. 90, issue C, 7-24

Abstract: Pension schemes generally aim to protect the purchasing power of their participants, but cannot completely do this when due to market incompleteness inflation risk cannot be fully hedged. Without a market price for inflation risk the value of a pension contract depends on the investor’s risk appetite and inflation risk exposure. We develop a valuation framework to deal with two sources of unhedgeable inflation risk: the absence of instruments to hedge general consumer price inflation risk and differences in group-specific consumption bundles from the economy-wide bundle. We find that the absence of financial instruments to hedge inflation risks may reduce lifetime welfare by up to 6% of certainty-equivalent consumption for commonly assumed degrees of risk aversion. Regulators face a dilemma as young (workers) and old participants (retirees) have different capacities to absorb losses from unhedgeable inflation risks and as a consequence have a different risk appetite.

Keywords: Unhedgeable inflation risk; Welfare loss; Incomplete markets; Pension contract; Valuation (search for similar items in EconPapers)
JEL-codes: C61 E21 G11 G23 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Working Paper: Unhedgeable Inflation Risk within Pension Schemes (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:90:y:2020:i:c:p:7-24

DOI: 10.1016/j.insmatheco.2019.10.009

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