On pessimism and optimism by forward looking agents and the need for pensions

Abstract

We study whether pessimism and optimism about the future by forward looking agents provides a rationale for pensions. We first distinguish between an agent’s true and pessimistic preferences and then analyze whether this agent’s level of saving depends on the pessimism parameter (π) and how welfare measured by the agent’s true preferences depends on π. Next, we examine whether it is possible for pessimism to increase the agent’s true utility and then show that this kind of pessimism does not provide a rationale for pensions. Moving on to optimism, we study the need for a pay-as-you-go (PAYG) pension system when the agent is optimistic about the generosity of the PAYG system. This optimism is modeled with a parameter (ω). In this setting, we first study the impact that an increase in ω has on the agent’s saving and then examine whether this agent’s welfare increases or decreases in ω. Finally, we show that this kind of optimism does not justify the presence of the PAYG pension system.