Project With Barbara Sanders & Jean-François Bégin

Intergenerational Risk Sharing in Funded Pension Plans: A Game-Theoretic Approach

Most funded pension plans rely on intergenerational risk sharing to create stable retirement income: when deficits arise, generations can provide subsidies instead of reducing pension benefits. Studies have shown that this type of cooperation is beneficial to all participants because reducing uncertainty in retirement increases the expected utility of members’ consumption over their lifetime. Yet this cooperation has limits: for instance, the younger generation might be unwilling to subsidize the older generation when the deficit is too large. When this limit is exceeded, tensions between generations might lead to the demise of the pension plan.

To address the threat of non-cooperation, game theory can be used to design self-enforceable pension contracts, i.e., ones that reduce tension by taking into account each generation’s self-interest. Recently, Wang (2018) explored the threshold above which cooperation in funded pension plans should not be enforced. In her model, the younger generation’s cost of cooperation is capped from above but not from below: the young can grasp all the upside potential from the old but only bear the downside risk up to a  certain limit. In addition, cooperation is an all-or-nothing deal in Wang’s framework: either there is full cooperation or there is none.

This USRA project (May 2019 to August 2019) aims to put forward two generalizations of the work of Wang (2018): applying a lower bound to the cost of cooperation for a more equitable treatment of surpluses and exploring partial cooperation. Specifically, the student will be responsible for:

  1. Familiarizing themselves with the current literature on game theory, especially with respect to applications to pension funds.
  2. Extending Wang’s (2018) game-theoretic framework as described above.
  3. Writing code to implement the model.
  4. Documenting all work.