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Social Security and the Interactions Between Aggregate and Idiosyncratic Risk

Alexander Ludwig () and Daniel Harenberg

No 936, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: We ask whether a PAYG financed social security system is welfare improving in an economy with idiosyncratic and aggregate risk. We argue that interactions between the two risks are important for this question. One is a direct interaction in form of a countercyclical variance of idiosyncratic income risk. The other indirectly emerges over a household's life-cycle because retirement savings contain the history of idiosyncratic and aggregate shocks. We show that this leads to risk interactions even when risks are statistically independent. In our quantitative analysis, we find that introducing social security with a contribution rate of two percent leads to welfare gains of 2.2% of life-time consumption in expectation, despite substantial crowding out of capital. This welfare gain stands in contrast to the welfare losses documented in the previous literature which studies one risk in isolation. We show that jointly modeling both risks is crucial: 60% of the welfare benefits from insurance result from the interactions of risks.

Date: 2014
New Economics Papers: this item is included in nep-age, nep-dge and nep-ias
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Working Paper: Social Security and the Interactions Between Aggregate and Idiosyncratic Risk (2014) Downloads
Working Paper: Social Security and the Interactions Between Aggregate and Idiosyncratic Risk (2014) Downloads
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More papers in 2014 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
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