Optimal investment and Pension policy in Pay-As-You-Go systems under forward utility and ageing population

TL;DR

This paper derives optimal investment and pension policies for a PAYG system with a buffer fund, considering demographic and economic factors, using forward utility and sustainability constraints.

Contribution

It provides closed-form solutions for policies and analyzes the impact of preferences on pension scheme sustainability and adequacy.

Findings

Closed-form optimal policies are characterized.

Preference sensitivities significantly influence pension scheme outcomes.

Numerical analysis evaluates scheme performance under various scenarios.

Abstract

This paper investigates optimal investment and pension policies in a Pay-As-You-Go (PAYG) system supplemented by a buffer fund used as an intergenerational risk-sharing mechanism. The social planner's preference criterion is represented by non-zero volatility forward Constant Relative Risk Aversion (CRRA) utilities, and explicitly accounts for both sustainability and adequacy constraints. The optimal policies are characterized in closed form, and an in-depth analysis of the impact of preference sensitivities on the pension scheme is conducted. A detailed numerical analysis is performed to evaluate the sustainability and benefit adequacy of this hybrid PAYG buffer fund arrangement under a range of demographic, financial, and macroeconomic scenarios.