Intergenerational Risk Sharing in the Spirit of Arrow, Debreu, and Rawls, with Applications to Social Security Design

Abstract

This paper examines the optimal allocation of risk in an overlapping‐generations economy. It compares the allocation of risk the economy reaches naturally to the allocation that would be reached if generations behind a Rawlsian “veil of ignorance” could share risk with one another through complete Arrow‐Debreu contingent‐claims markets. The paper then examines how the government might implement optimal intergenerational risk sharing with a social security system. One conclusion is that the system must either hold equity claims to capital or negatively index benefits to equity returns.