Pensions as a portfolio problem: fixed contribution rates vs. fixed replacement rates reconsidered

Pay-as-you-go (PAYG) pension schemes can contribute to better intergenerational risk-sharing and diversification. However, different variants of PAYG schemes entail different properties in these respects. In a stochastic 2-OLG model we compare PAYG schemes with fixed contribution rates and such with fixed replacement rates. The literature has shown that the former are preferable to the later from an ex ante perspective. We derive the opposite result for the ex post perspective. Here, schemes with fixed replacement rates are unambiguously preferable: they enhance intergenerational risk-sharing, lead to a higher savings and higher utility levels. We further show that, from an ex ante (veil-of-ignorance), perspective both schemes are non-comparable if the effect that fixed-replacement schemes serve as an insurance device for old-age income is properly accounted for. Received: 7 December 2000/Accepted: 17 May 2001