NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Junior Must Pay: Pricing the Implicit Put in Privatizing Social Security

George M. Constantinides, John B. Donaldson, Rajnish Mehra

NBER Working Paper No. 8906
Issued in April 2002
NBER Program(s):   AG   AP   PE

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.

download in pdf format
   (1279 K)

email paper

The NBER Bulletin on Aging and Health provides summaries of publications like this.  You can sign up to receive the NBER Bulletin on Aging and Health by email.

This paper is available as PDF (1279 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w8906

Published: Constantinides, G. M., J. B. Donaldson and R. Mehra. "Junior Must Pay: Pricing The Implicit Put In Privatizing Social Security," Annals of Finance, 2005, v1(1,Jan), 1-34.

Users who downloaded this paper also downloaded these:
Feldstein and Samwick w6540 Maintaining Social Security Benefits and Tax Rates through Personal Retirement Accounts: An Update Based on the 1998 Social Security Trustees Report
Nishiyama and Smetters w11622 Does Social Security Privatization Produce Efficiency Gains?
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us