The Market Value of Social Security

John Geanakoplos, Stephen P. Zeldes

NBER Retirement Research Center Paper No. NB 08-11
Issued in September 2008

How much are the accrued benefits of workers worth today? How much is the Social Security system in deficit? The traditional actuarial answer is to ignore risk and compute expected value. If benefits are risky and this risk is “priced” by the market, then the actuarial estimates will differ from market value. The exact adjustment for risk requires a careful examination of the stream of future benefits. The U.S. Social Security system is “wage-indexed”, i.e. future benefits depend directly on the realization of the future economy-wide average wage index. We assume that there is a positive long-run correlation between average labor earnings and the stock market. We then use derivative pricing methods standard in the finance literature to compute the market price of individual claims on future benefits, which depend on age and on the macro state variables We find that the difference between market valuation and “actuarial” valuation is large, especially when valuing the benefits of younger cohorts. The market value of accrued benefits is only 2/3 of that implied by the actuarial approach. The market value of the 75-year deficit is 30% lower than the actuarial estimate.

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Acknowledgments