Intergenerational risk shifting through social security and bailout politics

This paper adopts a stochastic overlapping generations framework to analyze the allocation of aggregate financial risks under different social security systems and a majority voting rule. We study whether there will be switches between pay-as-you-go (PAYG) and fully funded (FF) systems in such an economy. We show that in case of a negative aggregate shock, low-income young individuals will form a political coalition with the elderly to implement a PAYG system. PAYG scheme is shown to persist even after a good aggregate shock if the system is redistributive enough.