TY - JOUR AU - Constantinides,George M. AU - Donaldson,John B. AU - Mehra,Rajnish TI - Junior Must Pay: Pricing the Implicit Put in Privatizing Social Security JF - National Bureau of Economic Research Working Paper Series VL - No. 8906 PY - 2002 Y2 - April 2002 UR - http://www.nber.org/papers/w8906 L1 - http://www.nber.org/papers/w8906.pdf N1 - Author contact info: George M. Constantinides The University of Chicago Booth School of Business 5807 South Woodlawn Avenue Chicago, IL 60637 Tel: 773/702-7258 Fax: 773/753-8045 (773) 753-8045 E-Mail: gmc@ChicagoBooth.edu John B. Donaldson Columbia Business School 3022 Broadway, Uris Hall New York, NY 10027-6902 Tel: 212/854-3401 E-Mail: jd34@columbia.edu Rajnish Mehra Department of Economics W. P. Carey School of Business Arizona State University PO Box 879801 Tempe, AZ 85287-9801 Tel: 480 965-6335 Fax: 480 965-0748 E-Mail: rajnish.mehra@asu.edu AB - 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. ER -