Risk management of pensions from the perspective of loss aversion

This paper studies two interrelated questions. First, is a pay-as-you-go (PAYG) pension component beneficial from a risk management point of view? Second, does optimal risk management of old-age consumption differ between different income groups? The analysis is based on so-called lexicographic loss aversion preferences. Interest in these preferences stems from the fact that they explain the cross-section of individuals' savings and asset allocation choices better than alternative models. I find that all income groups benefit from the presence of a substantial PAYG component. Only for the two highest income quintiles old-age provision should heavily rely on equity investments.