Economics Seminar - "The Impact of Pension Plan Shift on Household Risk Exposure"

In recent decades, households in the US have been facing greater uncertainties in retirement wealth from employment-based pension plans, as employers move from offering defined-benefit (DB) pensions to defined-contribution (DC) pensions. In this paper, I quantify the extent to which this shift in workplace pension plans affects households’ portfolio choices and risk exposure. I build a life cycle model with two pension plans, incorporating stochastic risky asset returns, idiosyncratic earnings shocks, and endogenous labor supply. I find that households' risk exposure increases from 3.24% to 6.73% in a DC pension dominant environment. Despite exposure to risky assets through pension accounts, households under DC pensions ``fly-to-yield'' on the intensive margin by having a smaller weight in their portfolio on safe assets and a higher weight on privately-invested risky assets, contrary to what standard theories would suggest. On the extensive margin, a higher proportion of DC-pension households participate in the stock market. ``Flight-to-yield'' happens along both margins due to households’ contributions into DC accounts, which tighten their budget constraints and increases the marginal return of wealth. This effect is stronger for younger workers when their wealth accumulation is relatively low. The higher level of risky asset accumulation for DC pension households results in higher consumption during retirement absent adverse shocks. However, when hit by aggregate adverse financial shocks, households with DC pensions experience a 4.3 percentage point larger drop in consumption and take longer to recover, which increases the likelihood of a severe consumption driven recession in a DC-pension dominated economy.