Junior Must Pay: Pricing the Implicit Put in Privatizing Social Security / George M. Constantinides, John B. Donaldson, Rajnish Mehra.

Format:

Book

Author/Creator:

Constantinides, George M.

Contributor:

National Bureau of Economic Research.

Donaldson, John B.

Mehra, Rajnish.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8906.

NBER working paper series no. w8906

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Junior Must Pay

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2002.

Summary:

Proposals that portion of the Social Security Trust Fund assets be invested in equities entail the possibility that a severe decline in equity prices renders the Fund assets insufficient to provide the currently mandated level of benefits. In this event, existing taxpayers may be compelled to act as insurers of last resort. The cost to taxpayers of such an implicit commitment equals the value of a put option with payoff equal to the benefit's shortfall. We calibrate an OLG model that generates realistic equity premia and value the put. With 20 percent of the Fund assets invested in equities, the highest level currently under serious discussion, we value a put that guarantees the currently mandated level of benefits at one percent of GDP, or a temporary increase in Social Security taxation of at most 25 percent. We value a put that guarantees 90 percent of benefits at merely .03 percent of GDP. In contrast to earlier literature, our results account for the significant changes in the distribution of security returns resulting from Trust Fund purchases. We also explore the inter-generational welfare implications of the guarantee.

Notes:

Print version record

April 2002.