Political Risk and Discount Rates: Evidence from the Croatian Pension System

Jeffrey Brown, Zoran Ivković, Scott Weisbenner

NBER Retirement Research Center Paper No. NB 10-07
Issued in September 2010

Many transactions between citizens and government - such as those related to the provision of future pension income - have an important inter-temporal element. In such settings, individuals may discount future cash flows more heavily if their confidence or trust in the government as the counter-party to the transaction is low. In this paper, we examine an economically meaningful choice faced by retirees in response to a Constitutional Court ruling over whether to accept a small, immediate pension payment or a stream of larger, delayed payments. Approximately 70 percent of retirees chose the more immediate payments, despite the fact that the deferred option provided a nominal internal rate-of-return in excess of 26 percent. We first document that these individual decisions are correlated in sensible ways with a wide range of covariates, including education, income, liquidity constraints, and longevity expectations. We then show that, even after controlling for such factors, individual choices are strongly influenced by their views about government policy parameters (e.g., inflation and exchange rate expectations), their overall confidence in government, as well as their views about the importance of receiving "the full amount owed" from the government. These findings indicate that a citizenry's confidence in government can have important implications for how citizens value future benefit promises.

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