Fair and Sustainable Pension System: Market Equilibrium Using Implied Options

Abstract

This study contributes to the discussion about a fair and balanced pension system with a collectively funded pension scheme or social security and a defined contribution pillar. With an invigorated risk approach using financial option positions, it considers the variance of socioeconomic interests of different society-earning cohorts. By that, it enables the assumption of un-uniformity in interests about the fair and sustainable pension design. Specifically, we claim that the alternative cost of hedging the ideal position to the counterparty position studies the implied risks and returns that participants are willing to absorb and hence may lead to a fair compromise when there are different interests. The novelty of the introduced method is mainly based on the variety of participants’ risks and not on the utility function. Accordingly, we spare the discussion about the right shape of the utility function and the proper calibrations.

Keywords

• defined contribution (DC)
• pay as you go (PAYG)
• put option
• social security