Pension Research Centre (PeRCent)


An Analysis of the Solvency II Regulatory Framework’s Smith-Wilson Model for the Term
Structure of Risk-free Interest Rates (completed)

Title: PDF icon An Analysis of the Solvency II Regulatory Framework’s Smith-Wilson Model for the Term Structure of Risk-free Interest Rates

Participants: Peter Løchte Jørgensen (Aarhus University)

Description: In the European Union the financial regulation requires life and pension (L&P) companies to use a specific model for the term structure of risk-free interest rates – the Smith and Wilson (2000) model – when valuing their liabilities and long term guarantees. Since the Smith-Wilson model is not one of finance theory’s standard term structure models we provide an introduction to this model and we describe how the European Solvency II regulation came to embrace this particular model. The paper moves on to document how the regulation also imposes quite detailed and tight restrictions on how this model should be parameterized and applied. We argue that many of these implementation instructions seem biased in the same direction and that they could thus indicate a systematic attempt to "lift" the term structure curve up and away from its true location. The result is not only significant undervaluation of L&P liabilities but also a peculiar contradiction of Solvency II’s overall objective of enhancing financial stability and of protecting policyholders via the promotion of economic valuation in accordance with market consistent principles. The paper’s analysis is accompanied by valuation illustrations based on data on the liability composition of an actual medium-sized Danish pension fund.
Bargaining over Risk: The Impact of Decision Power on Household Portfolios
Title: Bargaining over Risk: The Impact of Decision Power on Household Portfolios

Participants: Arna Olafsson (FI, CBS)

Description: This paper investigates the internal financial decision-making process of households by employing a unique panel dataset containing the disaggregated wealth of the entire Swedish population over seven years. We directly estimate the outside options of spouses that determine their decision power and utilize a source of exogenous variation in sex-specific labor demand to show that its distribution among spouses is a driving force in the aggregation of spouses' preferences in financial decision making. As the decision power of female spouses grows, participation in the equity market decreases, participation in other risky asset markets increases, the share of wealth allocated to risky investments decreases, the riskiness of the portfolio decreases, and idiosyncratic risk decreases. We also study the effect of underdiversification on household welfare and find that women exert the in uence of their decision power to reduce the cost of underdiversification.


Comparison of Variable Annuities between the Netherlands and Denmark
Title: PDF icon Comparison of Variable Annuities between the Netherlands and Denmark

Participants: Anne G. Balter (Tilburg University), Malene Kallestrup-Lamb (Aarhus University) and Jesper Rangvid (FI, CBS)

Description: Both in the Netherlands and in Denmark regulators are currently revising the regulation of pension guarantees. Since the financial crisis, pensions have been cut in the Netherlands. Therefore, relaxation of guarantees fits the characteristics of a realistic future more. The embedded uncertainty is explicitly described in a variable annuity product, which is since September1, 2016 an allowed pension product in The Netherlands. And which always existed in Denmark but gained much popularity only recently. In this paper, we consider the differences between the Dutch and Danish variable annuity products and we describe the differences in the associated regulation and direction of the pension reform discussion. Consensus exists in the discussion that the pension system reform should adequately inform all participants about the risks and expectations. Moreover, in both countries the regulation that is currently under development, aims at a transparent system allowing for a comparison of different products.
Credit Smoothing
Title: Credit Smoothing

Participant: Arna Olafsson (FI, CBS)

Description: Standard economic theory says that unsecured, high-interest, short-term loans – such as borrowing via credit cards and bank overdraft facilities – helps individuals smooth consumption in the event of transitory income shocks. This paper shows that—on average—individuals do not use such borrowing to smooth consumption when they experience the typical transitory income shock of unemployment. Rather, it appears as if individuals smooth their roll-over credit card debts and overdrafts. We first use detailed longitudinal information on debit and credit card transactions, account balances, and credit lines from a financial aggregator in Iceland to document that unemployment does not induce a borrowing response at the individual level. We then replicate this finding in a representative sample of U.S. credit card holders, instrumenting local changes in employment using a Bartik (1991)-style instrument. The absence of a borrowing response occurs even when credit supply is ample and liquidity constraints, captured by credit limits, do not bind. This finding stands in contrast to the prediction of strictly countercyclical demand for credit by theories of consumption smoothing. On the contrary, demand for credit appears to be procyclical, which may deepen business cycle fluctuations.


Do Savings Mandates Cause Debt Accumulation? 
Title: Do Savings Mandates Cause Debt Accumulation?

Participants: Asger Lau Andersen (University of Copenhagen) and Henrik Yde Andersen (ECON, CBS and Danmarks Nationalbank) 

Description: In Denmark -- as in many other countries -- defined contribution pension schemes have gained increasing importance. In a recent study Chetty et al (2014) use population-wide Danish data with information about savings and total wealth to show that these savings mandates lead people to increase their total savings, even if they have enough financial wealth that can be adjusted to keep total savings constant. This happens because they respond passively to the savings mandates. In the short run passive responses imply that households adjust spending when they are exposed to savings mandates. However, nothing is known about the long run consequences of savings mandates. Do they lead to increased (mortgage) borrowing so that people can maintain their original consumption level, or do people reach the retirement age with higher levels of net wealth? The purpose of the present project is to answer:

Do people, who save extra because they responded passively to a savings mandate, take out more mortgage debt to maintain their original level of spending, or do they end up with more wealth when they approach retirement? To answer this question, we will make use of Danish administrative registry data with information about jobs, income, wealth and pension savings for the entire Danish population since 1980. To quantify the size of the savings mistake following a savings mandate we will use the event-study design proposed by Chetty et al. (2014). Specifically, we will consider job switches associated with a change in mandated savings rates and show that mandates generate a sharp change in savings that pass-through to total asset accumulation. Changing jobs can be associated with a change in total compensation. It is straightforward to control for this as the tax records hold detailed information about this. The design exploits the longitudinal dimension and massive size of the data, and the institutional structure where mandated retirement savings rates vary significantly across firms because of differences in collective bargaining agreements. In Chetty et al. (2014) we show that total savings rates are completely stable in the period leading up to the job switch and change sharply at the job switch. Unless preferences for savings change sharply at the job switch, this is consistent with the assumption that preferences for saving are orthogonal to job switches.

To test the hypothesis that passive decision makers target spending we measure whether savings mandates generate an increase in total accumulation of assets that can predict the uptake of mortgage debt after the job shift. Because we observe all components of the household budget constraint we are able to quantify the costs (in consumption equivalents) associated with being a passive decision maker. Another possible margin of adjustment is that people end-up retiring at a different point in time compared to people who are not exposed to savings mandates, or to have a different level of spending in retirement. Because labor market activity and complete household balance sheets are observed in the administrative data it is possible to investigate all of these alternative hypotheses.

Reference: Chetty; Friedman; Leth-Petersen; Nielsen; Olsen. 2014; Active vs. Passive Decisions and Crowd-Out in Retirement Savings: Evidence from Denmark; Quar. J. Ec. 129(3).
Essays on Macroeconomic Implications of Demographic Change
Title: Macroeconomic Implications of Changing Demographics (PhD project, together with Central Bank of Iceland)

Participant: Thorsteinn S. Sveinsson (ECON, CBS and Central Bank of Iceland)

Demographic change is becoming increasingly important to the economic wellbeing of industrialized countries. These changes bring with them a set of implications, among which are the sustainability of public finance, pension- and social security systems. These implication cause a response, the span of which can range from pension reforms and fiscal policy to the individual’s life cycle plan. Understanding the economic implication of these demographic changes is instrumental to a sound resolution of the issues they spark. This dissertation is composed of four independent chapters, all of which are concerned with the economic implications of demographic change.
Chapter one, “Sustainable fiscal strategies under changing demographics”, develops an overlapping generations model to evaluate, first, the steady state growth maximizing level of public debt around which an economy needs to stabilize; second, how the optimal level of public debt varies as a function of key population parameters; third, how fiscal rules designed to stabilize the economy around that debt level need to vary with the population parameters; and, fourth, how well the model performs as a reasonable and plausible representation of the advanced economies that face fiscal strain and deteriorating demographics. The main conclusion is: despite diminished fiscal space and flexibility due to deteriorating population parameters, a relatively benign steady state is feasible and available under mild fiscal restraints. The bigger problem will be how to get there without financial or fiscal breakdowns along the way. We offer some political economy perspectives on how best to manage that risk.
Chapter two, “Reform and Backlash to Reform: Longevity Adjustment of the Retirement Age”, uses an overlapping generations model, ad modum Blanchard-Yaari, to analyse the effects of retirement reform on labour supply, and found there is not a one-to-one relationship between an increase in the statutory retirement age and the corresponding increase in aggregate labour supply: Rather, a backlash effect is observed, where a reform aimed at broadening the labour supply on the extensive margin, has the unintended effect of decreasing labour supply on the intensive margin. Following a calibration exercise to analyse the robustness of these backlash effects on different pension scheme designs, we found that, under a defined-benefit scheme, the effects on the intensive margin of labour supply are drastically increased, compared to the defined-contribution scheme and the fully-funded scheme.
Chapter three, “Longevity, Pension Reform and Intra-Generational Equity”, finds that segments of society who have shorter life expectancy can expect a lower income from their pensions and lifetime utility due to the longevity of other groups participating in the same pension scheme. Linking the pension age to average life expectancy magnifies the negative effect on the lifetime utility of those who suffer low longevity. Furthermore, when the income of those with greater longevity increases, those with shorter life expectancy become even worse off. Conversely, when the income of those with shorter life expectancy increases, they end up paying more into the pension scheme, which benefits those who live longer. The relative sizes of the low and high longevity groups in the population determine the magnitude of these effects. We calibrate the model based on data on differences in life expectancy of different socio-economic groups and find that low-income workers suffer from a 10-13 percent drop in pension benefits from being forced to pay into the same scheme as high-income workers.
Chapter four, “Healthy aging, saving and retirement”, argues that healthy aging is an essential factor in individuals’ retirement behaviour and should therefore be considered in the design of retirement reforms. A model is constructed where agents make consumption, saving, and retirement decisions based on their expectations of future health and their uncertainty about their time of death. Changes in health shift the agent’s utility curve and increase the disutility of work, providing a connection between healthy aging and the agent’s life-cycle decisions. The author finds, among other things, that healthy aging is associated with later retirement and that as the risk of adverse health shocks increases, the agent saves less. Life-cycle health developments are found to explain to an extent the hump-shape of the individual’s consumption plan. These effects are established with various formulations of health functions and simulated with data on life-cycle health and longevity to obtain estimates of the impact of healthy aging on retirement decisions.
Essays on Pension Savings
Title: Essays on Pension Savings (PhD project, together with Danmarks Nationalbank)

Participant: Henrik Yde Andersen (ECON, CBS and Danmarks Nationalbank)

Description: The project is comprised of three self-contained chapters concerned with the interplay between pension saving systems and household saving and debt decisions.

Chapter 1, “Do Tax Incentives for Saving in Pension Accounts Cause Debt Accumulation? Evidence from Danish Register Data", investigates if tax incentives for saving in pension accounts affect individual debt accumulation. Applying a quasi-experimental research design on a Danish 2010 policy that reduced tax incentives for saving in annuity pension schemes, we show significant substitution of savings from retirement accounts to gross debt repayments. We find that for every 1 Danish Krone that retirement savings are reduced about 30 cents go to debt repayments. Taking into account all types of savings, we find full crowd-out. Consistent with previous findings, we document that the effect is driven by a minority, about 23%, who actively rebalance their savings.

Chapter 2, “Mandatory Pension Savings and Household Debt”, asks the question if compulsory pension contributions make homeowners repay less debt or even increase borrowing. Access to individual-level information on pension contributions, bank debt and mortgages allows us to investigate exactly this. We exploit exogenous variation from job changes to identify active changes in mortgage and bank debt repayments. Conditional on increasing mandatory pension contributions when taking up a new job, we argue that decreased debt repayments can be causally linked to increased compulsory pension saving rates.

Chapter 3, “Is there a Housing Wealth Effect”, tests whether unexpected changes in house prices affect individual consumption and savings decision. To do this we use longitudinal survey data with subjective information about current and expected future house prices to calculate unanticipated house price changes. We link this information to high quality administrative records with information about savings in various financial instruments. These data makes it possible to regress spending as well as savings in different types of assets and liabilities on direct measures of anticipated and unanticipated innovations to house prices. Controlling for competing explanations we find that an unanticipated increase in housing wealth that compares to one year’s worth of income leads to an increase in spending (also measured relative to income) of 3-5 percent. The spending increase is followed by a corresponding drop in the following year suggesting that the effect is driven by spending on durable goods. The estimated effect is driven by about 8 percent of the households in the sample who actively refinance their mortgage loan and extract equity to finance the spending increase.


Essays on Pensions and Fiscal Sustainability
Title: Essays on Pensions and Fiscal Sustainability (PhD project, together with Statistics Denmark)

Participants: Filipe Vieira (ECON, CBS and Statistics Denmark)

Description: This PhD project is article based, containing three essays. On one side, this project studies sustainability issues in the fiscal perspective of government debt and public provision of unfunded pension benefits. On the other side, the focus shifts to households and their wealth and debt.

Essay 1: “Changing Demographics and Optimal Public Debt", investigates the link between anticipated demographic changes and growth maximizing public debt. The analysis is based on an OLG model with age related social spending (through benefits), cost of child rearing, retirement and stochastic death. We find that optimal public debt depends on age related spending provided a positive benefits rate. Through numerical analysis we conclude that the effect of future demographic changes on the optimal debt level are relatively benign in the typical OECD economy. This essay invites a host of extensions, such as analysis of transition paths between steady states, introduction of a public pension system, a small open economy version and simulation of specific economies.

Essay 2: “Reform and Backlash to Reform: Macroeconomic Effects of Longevity Adjustment to the Retirement Age and Public Pension Benefits”, analyses pension reforms aimed at mitigating the effects of demographic changes. By applying an OLG model it examines the consumption-savings decisions of agents faced with a rise in the retirement age. This continuous time model is based on the Blanchard-Yaari framework and features a public pension system. We find that as the labour output is raised at the extensive margin (i.e. raised retirement age) the labour output on the intensive margin decreases (i.e. young agents allocate more time to leisure). This implies a substitution effect between current leisure choice of the young cohort and anticipated retirement age. This essay could be extended to introduce government spending aimed at alleviating the burden of intergenerational transfers through deficits.

Essay 3: (TBD), the third essay has not yet been precisely established.
Experiences with Occupational Pensions in Denmark
Title: Experiences with Occupational Pensions in Denmark

Participant: Svend E. Hougaard Jensen (ECON, CBS)

Description: TBA
External Asset Positions, Demography and Life-cycle Portfolio Choice
Title: External Asset Positions, Demography and Life-cycle Portfolio Choice

Participant: Katja Mann (ECON, CBS)

Description: How do demographic differences between regions affect external positions in safe and risky assets? We answer this question focusing on the US vis-a-vis 15 ` European Union member states. The US bilateral position is characterized by risky assets alongside safe liabilities. At the same time, the US population is relatively younger. We present a structural model of two fully integrated regions, which differ by the age structure of their populations. There are multiple overlapping generations of agents, who choose a portfolio of safe and risky assets over the life-cycle. We show that the younger region has a higher relative demand for risky assets, which induces international asset trades. In a simulation starting in 1990, we replicate the observed positions between the US and the European countries both in sign and in magnitude. We predict the risk asymmetry to persist until the end of the century, whereas both safe and risky returns decline persistently.


Family Finances: Intra-Household Bargaining, Spending, and Capital Structure
Title: Family Finances: Intra-Household Bargaining, Spending, and Capital Structure

Participant: Arna Olafsson (FI, CBS)

DescriptionFinancial decisions are mostly made jointly within households and in order to understand how households determine, for instance, how much to save, how much to consume and how risky their portfolios should be, which determines how well prepared they are for retirement, we need to further our understanding of the internal financial decision-making process of households. This paper aims to test recent influential theories proposing that differences in preferences of household members lead to agency problems reflected in overspending, indebtedness, and financial fee expenses at the household level. To do so, we use comprehensive transaction-level data from individuals within households. Observing individuals within households over the life cycle gives us a unique opportunity to empirically examine how individual revealed preferences over discretionary spending and debt holdings varies by age and affect spending and indebtedness at the household level. To deal with cndogcneity, we use a fixed effects and instrumental variable approach, which hdps us tackle both self-selection and common-shocks issues. We document that the share of household income received by the spender (or debt-inclined) spouse causally increases discretionary spending ( or household debt), controlling for total household income. Moreover, we estimate individual marginal propensities to consume and link the within-household differences to debt and fee expenses at the household level. Our results arc consistent with individuals having different preferences over spending and using expensive debt and exerting their preferences with the bargaining power that income gives them. Furthermore, we document that individuals' marginal propensity to consume falls over the life cycle. 
FinTech Adoption Across Generations: Financial Fitness in the Information Age
Title: FinTech Adoption Across Generations: Financial Fitness in the Information Age

Participant: Arna Olafsson (FI, CBS)

Description: This paper analyzes how better access to financial information via new technology changes use of consumer credit and affects financial fitness. We exploit the introduction of a smartphone application for personal financial management as a source of exogenous variation. FinTech adoption reduces financial fee payments and penalties, but differs cross-sectionally in the population. After adopting the new technology, Millennials and members of Generation X incur fewer financial fees and penalties, whereas Baby Boomers do not benefit from the technological advance. Millennials and Gen Xers save fees by using their credit cards rather than overdrafts to manage short-term liabilities. Moreover, Millennials shift some of their spending to discretionary entertainment, whereas members of Generation X remain more austere. Finally, while men tend to adopt new technology and access information at a higher rate, the economic impact of access is larger for women.


From here to there: transition paths from high debt to sustainable fiscal strategies under
adverse demographics

Title: From here to there: transition paths from high debt to sustainable fiscal strategies under adverse demographics

Participants: Andrew Hughes Hallett (University of St Andrews), Svend E. Hougaard Jensen (ECON CBS), Thorsteinn S. Sveinsson (ECON, CBS and Central Bank of Iceland) and Filipe Vieira (ECON, CBS and Statistics Denmark)
Household Bargaining, Pensions, and Risk Management Schemes for Families (completed)
Title: Household Bargaining, Pensions, and Risk Management Schemes for Families

Participants: Jimmy Martinez-Correa (ECON, CBS) and Mauricio Prado (ECON, CBS)

Description: We are interested on how couples make joint risk management choices (e.g., financial investment, insurance, and saving for pension). Such choices are very difficult to identity in Danish Registry data and that is the reason why we ran a unique laboratory experiment that allowed us to study in detail how couples make joint choices and compare them with individuals that have been randomly matched into pairs. This is a unique opportunity to study what is special about how established couples make choices. The outcome of our analysis will shed light on what makes it easier for households to make joint choices. We have preliminary interesting results that could be used, for instance, to make insurance products more appealing to households.

Our most interesting findings so far are the following:

  1. Classical theory of insurance tells us that with zero loading people should choose insurance as long as they are risk averse. So people should choose insurance no matter whether they are couples or not. We find that:

    a. Pairs of subjects in the experiment, no matter whether they are established couples or individuals randomly matched into pairs, demand individual insurance 60% of the times with no loading. In the experiment, pairs of subjects were given the choice to face individually a risky lottery or individually insure fully or partially against the risk of the lottery. Choices had to be made jointly and in a coordinated manner, so it was not possible that in a given pair of subjects an individual chose no insurance and the other chose to insure. Subjects had to either choose to insure or not to insure in a coordinated manner.

    b. However, when there is loading, we observed a significant difference between established couples and individuals randomly matched into pairs. Couples chose more insurance (49% of the times) and non-couples chose less insurance (42% of the times). This difference is statistically significant and implies that couples are more risk averse than randomly matched pairs.
  2. An equal-split pricing mechanism makes couples behave more “rational” in the classical sense explained in finding #1. Couples tend to choose more insurance in the zero loading treatment when they are offered the equal splitting pricing. This equal splitting mechanism is a simple pricing mechanism that sums the price of insurance for each individual and then divides this total price by two. This means that the price for each individual is exactly half of the total price to insure both persons. When couples are not offered this equal splitting pricing, and instead are offered individual fair pricing to each subject, they tend to choose to insure less. Therefore, there seems to be something special about this equal-splitting mechanism that makes couples behave more rationally and insure more when they are expected to do so according to theory.  The equal splitting pricing makes, in some sense, the risk-averse households more “rational.”

We are continuing to analyze the data, and soon we will merge our experimental data to the registry data. This will allow us to study in more depth what are the profiles of households, according to demographics and other registry variables, that are important to explain the preliminary results above.

Housing in an Ageing Society – A Simulation Study
Title: Housing in an Ageing Society – A Simulation Study

Participants: Hans Fehr (University of Würzburg) and Svend E. Hougaard Jensen (ECON, CBS)
Description: Home ownership has important economic and social implications in a society. In order to pay back their mortgage redemption, actual and prospective home owners save more and tend to accumulate more wealth than renters. Typically home ownership increases over the life cycle. It becomes an important wealth component in retirement and provides an (implicit) annuity and insurance device against longevity risk. Therefore, especially ageing societies should benefit from efficient housing markets and high rates of home ownership. Quite surprisingly, despite huge tax incentives in most industrialized countries, ownership shares differ quite substantially across countries. So does the possession of financial wealth of older people in different countries. The projected population dynamics are also quite different. Moreover, countries differ in terms of their tax, pension and housing policy settings.
The proposed project aims to examine the asset accumulation and allocation in Denmark and Germany. To what extent can the differences in home ownership and financial assets be explained by differences in the population structure and dynamics? How important are institutional features such as the pension system, tax incentives or the market for mortgage loans? How does the ageing of the population affect the housing market in both countries the future? What are distributional and efficiency consequences of various tax and pension reforms in both countries? In order to answer these questions we will construct a computable general equilibrium (CGE) model with overlapping generations and uninsurable labour income which accounts for housing demand and home ownership.

The two research teams at the University of Würzburg and CBS will closely cooperate during the development of the model structure. Both models will apply the same preferences and technologies. However, they will differ in their population dynamics, their fiscal systems and their housing markets. Compared to similar previous quantitative studies, our approach offers three major innovations. First, we will not only consider steady state effects of policy changes but simulate the whole transition path in an ageing society. When we simulate the model with and without population dynamics we can identify the impact on ageing on the housing market. Second, when we implement policy reforms we will analyse intergenerational welfare changes. Finally, we plan to quantify the efficiency effects of policy reforms by means of lump‐sum compensation payments.

Both partners have previous working experience with quantitative life‐cycle models as well as pension and ageing issues in their respective countries. In our published simulation studies we typically analyse the transition path, intergenerational welfare effects and isolate aggregate efficiency consequences of specific policy reforms. However, our previous models never distinguished housing consumption and mortgage markets. Therefore the current project is a natural extension of our previous work. We want to integrate a PhD project with this research programme. We are convinced that the results from our project could be useful for the policy discussion both in Denmark and Germany. For example, in both countries the fear of future “old age poverty” is an important policy issue. Optimal policies that target the poor pensioners (for example by means‐testing) are therefore important in Denmark and Germany. Since both countries differ substantially in their current tax and transfer schemes we can hope that our study sheds some light on the advantages and disadvantages of the two systems.

Housing Wealth Effects and Mortgage Borrowing: The Effect of Subjective Unanticipated
House Price Changes on Home Equity Extraction

Title: Housing Wealth Effects and Mortgage Borrowing: The Effect of Subjective Unanticipated House Price Changes on Home Equity Extraction

Participant: Henrik Yde Andersen (ECON, CBS and Danmarks Nationalbank)

Description: In this paper we examine whether house price changes drive mortgage-based equity extraction. To do this we use longitudinal survey data with subjective information about current and expected future house prices to calculate unanticipated house price changes. We link this information at the individual level to high quality administrative records with information about mortgage borrowing as well as savings in various financial instruments. We find a marginal propensity to extract out of unanticipated housing wealth gains to be 2-5 per cent. We find no evidence that the effect is driven by collateral constraints. Instead, the effect is driven by about 11 per cent of the observations where the respondent is recorded having actively taken out a new mortgage. These results point to the existence of a housing wealth effect that is intimately connected to the functioning of the mortgage market, and this suggests that monetary policy could amplify the interaction between unanticipated housing wealth gains and spending by affecting the pass-through on interest rates on mortgage loans.
How do Interest-Only Mortgages Affect Consumption and Saving over the Life Cycle
Title: PDF icon How do Interest-Only Mortgages Affect Consumption and Saving over the Life Cycle

Participants: Linda S. Larsen (FI, CBS), Claus Munk (FI, CBS), Rikke Sejer Nielsen (FI, CBS) and Jesper Rangvid (FI, CBS)

Description: Using a unique data set with detailed information on households and their mortgages, we examine the pros and cons of interest-only (IO) mortgages. We find that households with IO mortgages are more leveraged and consume more than households with repayment mortgages. However, IO mortgages facilitate consumption smoothing for young households expecting increasing income and help financially constrained older households free up liquidity and thus avoid cutting consumption or selling their home. Compared to households with repayment mortgages, IO borrowers have a lower fraction of expensive non-mortgage debt, a higher stock market participation rate, and make larger pension contributions.



Mandatory pension saving and home ownership
Title: PDF icon Mandatory pension saving and home ownership

Participants: Marcel Fischer (FI, CBS and Universität Konstanz), Bjarne Astrup Jensen  (FI, CBS), Marlene Koch (Universität Konstanz)

Description: We explore the implications of mandatory minimum contributions to retirement accounts over the life cycle. These contributions alter housing market entry and have substantial welfare effects.  We propose a flexible retirement saving scheme that only requires individuals to contribute to retirement accounts if they have not built up sufficient savings. This flexible retirement saving scheme partly alleviates the unintended side effects of mandatory minimum contributions and simultaneously ensures that individuals build up sufficient retirement savings.
Occupational Pensions, Aggregate Saving and Fiscal Sustainability:
Evidence from Denmark (completed)

Title: Occupational Pensions, Aggregate Saving and Fiscal Sustainability: Evidence from Denmark

Participant: Svend E. Hougaard Jensen (ECON, CBS)

Description: The task of achieving long-term fiscal sustainability is to a considerable extent complicated by the fiscal strain posed by ageing populations and uncovered expected financial liabilities associated with future public sector outlays to pensions, health care etc. Evidently, this calls for an active reform agenda, such as postponing the retirement age and restructuring the pension system to rely more heavily on (individual as well as collective) retirement savings by households.

This paper focuses on the Danish pension system, which has attracted a lot of international attention in recent years. The system is highly ranked in global comparisons, and it has been seen as a role model for how to achieve good coverage, provision of adequate benefits and not least for its contributions to keep fiscal policy on a sustainable path. Yet, this paper argues that the system is subject to two important challenges:

First, due to means-testing of pension benefits, the effective return on occupational pension (OP) savings is very low, especially for low-income groups close to retirement age. There is a serious concern that unless this problem is appropriately addressed in the not so distant future, the payments to the OP system may be dramatically reduced. Against this background, the paper’s first contribution is to show how key fiscal and macroeconomic performance indicators would respond if payments to the OP system are phased out because of weak incentives to contribute to the OP schemes. 

Second, due to anticipated violations of the rules stipulated by the fiscal framework in the EU, Denmark might feel tempted to change the tax treatment of funded pensions. Like in most other member states, in Denmark OP contributions are tax deductible, whereas OP benefits are taxed. The paper argues that a change of this set-up, such that contributions are taxed while benefits are untaxed, could seriously endanger the sustainability of public finances. Given the poor performance of public finances throughout Europe, and the need for fiscal adjustments in order to comply with national as well as supranational criteria, this is a theme of wider interest.

This project outlines the OP system in Denmark; explains the analytical framework used throughout the study: the DREAM model; addresses the effects of a gradual phase-out of the OP schemes; studies the implications of abolishing the existing system of deferred taxation of OP savings; points out some lessons for other countries.

Payday Borrower´s Consumption: Revelation of Self-Control Problems
Title: Payday Borrower´s Consumption: Revelation of Self-Control Problems

Participant: Arna Olafsson (FI, CBS)

Description: We use a new and accurate panel dataset from a financial account aggregation app to analyze the liquidity and consumption of payday borrowers. In line with previous studies, we find that 35% of payday borrowers would be sufficiently liquid to borrow the money less expensively using their credit cards or checking-account overdrafts. Moreover, we do not document large decreases in liquidity before the borrowing event. With respect to consumption, we find that the average borrower uses the payday loan to fund spending on unnecessary and non-durable purchases such as alcohol and restaurants. Additionally, we establish a causal link from such spending, as opposed to income, to payday borrowing using weather as an instrument. These empirical observations help to gauge the welfare consequences of payday lending because they lend support to the behavioral view that payday borrowing is caused by either self-control problems or misunderstandings about the costs of borrowing and thus should be regulated.


Pension Taxation, Household Debt and the Real Economy
Title: Pension Taxation, Household Debt and the Real Economy

Participant: Henrik Yde Andersen (ECON, CBS and Danmarks Nationalbank)

Description: TBA
Pensions and Fiscal Imbalances in an Era of Demographic Change
Title: Pensions and Fiscal Imbalances in an Era of Demographic Change

Participants: Andrew Hughes Hallett (University of St Andrews), Svend E. Hougaard Jensen (ECON, CBS), Thorsteinn S. Sveinsson (ECON, CBS and Central Bank of Iceland) and Filipe Vieira (ECON, CBS and Statistics Denmark)

Description: Our analysis is based on an economy with successive generations of workers who produce, consume, save and have children when they are young; but consume, spend their pensions when retired. Adjustments are made for time spent out of the labour force (for child rearing) and for survival rate into retirement. Social support and the consequences of ageing are funded by a social security tax on income, paid out at uniform average benefit rate. This framework has already led to a couple papers (Bokan et al. 2016; Hughes Hallett et al., 2016). For example, we have shown how a country’s fiscal position and efficient (growth maximizing) debt burden increase or decrease with demographic change, such as increasing longevity or migration. 

Our agenda for what we plan to do next includes a range of topics, roughly in order of priority:

1) Examine the quality and potential risks in the macroeconomic and fiscal transition paths from the current position to the steady states we have identified. What does the best path look like?  This involves (i) a technical summary of what dynamics are possible/optimal; and (b) a political economy analysis of (the risks in) making these dynamic adjustments.

2) The consequences of building in a public pension system.

3) Compare different countries with different demographic or fiscal characteristics. What factors make the adjustment paths easier, or more difficult or riskier?

4) What difference does it make if the economy is open to trade and investment? Compare small open economies to a large, more closed economy.

5) Examine in more detail the role played by (or concern for) income inequality in the transition.


Bokan, N., A. Hughes Hallett and S. Hougaard Jensen (2016), Growth-Maximizing Public Debt under Changing Demographics, Macroeconomic Dynamics.

Hughes Hallett, A., S. Hougaard Jensen and T. S. Sveinsson (2016), Changing Demographics and Optimal Public Debt: A Steady State Analysis. Under review (OEP).

Studying Danish Inequality on a Comprehensive, Economic Basis
Title: Studying Danish Inequality on a Comprehensive, Economic Basis

Participant: Svend E. Hougaard Jensen (ECON, CBS)

Description: Pensions, both those provided by employers and those provided by the state, represent important forms of household wealth. Yet they are seldom incorporated in studies of inequality. Indeed, much of the concern about inequality stems from the concentration of net wealth.  For example, in the US, the richest 1 percent of households, ranked by their economic resources, account for almost 20 percent of the cohort's net wealth. This is obviously highly unequal. But would including pension and other forms of wealth, including human wealth change the picture? And doesn't one also need to account for negative wealth, specifically the present value of projected future taxes. The answer, of course, is yes. When one adds all the positive and negative wealth components together one arrives at lifetime spending power, which should be the real focus of inequality discussions. In the U.S., inequality in spending power is far smaller than is inequality in wealth. For example, the richest 1 percent of 40 year old households account for only 9 percent of spending power, i.e., top-1 percent inequality measured correctly is, for this cohort, less than half of what one would think from considering only net wealth. In this study, we would like to undertake a similar analysis for Denmark and would, of course, need to re-programme the model for Denmark.
The Consumption-Savings Puzzle and Intra-Household Dynamics
Title: The Consumption-Savings Puzzle and Intra-Household Dynamics

Participant: Arna Olafsson (FI, CBS)

Description: In this paper, we use a very accurate panel of individual spending and income to recover information on expenditure around retirement and how the effects differ by gender. The longitudinal nature of our data allows us to estimate fixed effects models, which help me tackle both self-selection and common­shocks issues. Our results show that total expenditure decreases at the time of retirement and that there is substantial heterogeneity in the retirement response across consumption categories where expenditure on ready-made-­food and vehicles is reduced the most. However, we find that the overall decline in spending post-retirement is largely attributable to wives retiring rather than husbands. Households spend less on ready-made-food and more in pharmacies when husbands retire, which is consistent with them retiring due to worse health and a reduction in work-related expenses like ready-made­-food during work time. However, when wives retire the household spends less on most consumption categories, which is consistent with women being responsible for a larger share of housework and therefore the expenditure in these categories is only affected when they retire. When looking at single individuals, the response to retirement is much more similar among men and women.
The debt tax shield, economic growth, and inequality
Title: PDF icon The debt tax shield, economic growth, and inequality

Participants: Marcel Fisher (FI, CBS) and Bjarne Astrup Jensen (FI, CBS)

Description: We study the implications of the corporate debt tax shield in a growth economy that taxes household income and firm profits and redistributes tax revenues via pension payments in an attempt to harmonize lifetime consumption opportunities of households that differ in their endowments. Our model predicts that the debt tax shield (1) increases the risk-free rate, (2) leads to a higher growth rate of the economy, and (3) increases the degree of disparity in households' lifetime consumption opportunities. We further quantify how the debt tax shield affects the trade-off between the goals of achieving a high growth rate of the economy and a low degree of inequality.
The Implications of the Decline of European Manufacturing for Productivity Growth and World Interest Rates
Title: The Implications of the Decline of European Manufacturing for Productivity Growth and World Interest Rates

Participant: Battista Severgnini (ECON, CBS)

Description: This project seeks to uncover the puzzle of the decline of manufacturing industry in Europe that started in the early 1990s, to understand its origins, and explore its significance for the world economy. It may help use to understand the persistent decline in real interest rates which has occurred across the world and especially in Europe over the same period.

First, we would like to understand the slowdown in manufacturing multifactor productivity in Europe which started in the early 1990s and continues to date. This is a new phenomenon that was certainly not recognized at the beginning of the millennium (see for example Blanchard and Solow’s well-known McKinsey (2002) study on European productivity). We would document this with high quality macro and possibly micro data, taking into account sectoral changes that have occurred in Europe over the past decades.

A second puzzle is that Europe’s decline in manufacturing is not uniform. In contrast to the findings of Rodrik (2013) for the world economy, labour and total factor productivity in manufacturing industry is diverging within Europe. It is also lagging behind that of the US in a process that seemed to begin in the early 1990s. In particular, southern Europe has fallen behind, while most of northern Europe has not. While this divergence in productivity has particular importance for the survival of the European Monetary Union, it began in the 1990s and is not, contrary to common opinion, with the introduction of the Euro. The puzzling rise and fall of productivity in Europe relative to the United States is best explained in a conditional regression analysis (Griffith et al. 2014) which admits a role for information technology investment and adoption, competition and openness, product and labor market regulation, and corruption.

This project has relevance for the current macroeconomic puzzle of low real interest rates. The EU represents more than 500 million consumers and more than 20% of the world’s GDP. A slowdown in business fixed capital formation in this part of the world and a reduced presence at the frontier of innovations in manufacturing would have global implications, not just for flows of global foreign direct investment, but also for the overall demand for capital goods. In the final part of the project we would investigate the implications of Europe’s slump for the world’s demand for investment, GDP growth in general, and the level of interest rates in the world.

Griffith, R., S. Redding, and J. Van Reenen 2004, “Mapping the Two Faces of R&D: Productivity Growth in a Panel of OECD Industries," The Review of Economics and Statistics, 86(4), 883-895.

McKinsey Global Institute 2002, “Reaching High Productivity Growth in France and Germany.” October.

Rodrik, D. 2013."Unconditional Convergence in Manufacturing," The Quarterly Journal of Economics, Oxford University Press, vol. 128(1), pages 165-204.

The Ostrich in the Us: Selective Attention to Financial Accounts, Income, Spending, and Liquidity
Title: The Ostrich in the Us: Selective Attention to Financial Accounts, Income, Spending, and Liquidity

Participant: Arna Olafsson (FI, CBS)

Description: A number of theoretical research papers in micro as well as macroeconomics model and analyze attention but direct empirical evidence remains scarce. This paper investigates the determinants of attention to financial accounts using panel data from a financial management software provider containing daily logins, discretionary spending, income, balances, and credit limits. We find that individuals are considerably more likely to log in because they get paid utilizing exogenous variation in paydays due to weekends and holidays. Beyond looking at the causal effect of income on attention, we examine how attention depends on individual spending, balances, and credit limits within individuals’ own histories. We find that attention is decreasing in spending and overdrafts and increasing in cash holdings, savings, and liquidity. Moreover, attention jumps discretely when balances change from negative to positive. We argue that our findings cannot be explained by rational theories of inattention. Instead our findings are consistent with Ostrich effects and anticipatory utility as the main motivation for paying attention to financial accounts and thus provide new tests for information- or belief-dependent utility models. Furthermore, we show that some of our findings can be explained by a recent influential one of those models (Kőszegi and Rabin, 2009), which assumes individuals experience utility over news or changes in expectations about consumption.


The Pension Gender Gap: Understanding Both Its Composition and Changes over Time
Title: The Pension Gender Gap: Understanding Both Its Composition and Changes over Time

Participants: Moira Daly (ECON, CBS) and Fane Groes (ECON, CBS)

Description: In the first project, we will explore the pension savings behavior of men and women in order to decompose the “pension gap”. Recently the pension gap has been a topic of discussion in the Danish media; Nordea and PFA document that women have saved 64 to 80 percent of what men have. To our knowledge, the determinants of this gap have not been fully investigated. Is this “pension gap” solely explained by lower lifetime earnings or do women tend to manage their savings differently than men? How are these decisions affected by household composition?

In the second project, we will study the effects of a major change in legislation in 2007 that affected how pensions are split between husbands and wives in the event of divorce.  We will determine  whether or not this change in legislation altered the savings behaviour of married men and women, and if so, determine the immediate consequences of this change of legislation on the stability of families, and subsequently, on children.
The Retirement-Consumption Puzzle: New Evidence on Individual Spending and Capital Structure
Title: The Retirement-Consumption Puzzle: New Evidence on Individual Spending and Capital Structure

Participant: Arna Olafsson (FI, CBS)

Description: In this paper, we use an accurate panel of individual spending, income, and financial account balances to learn more about expenditure and household financial structure changes around retirement. The longitudinal nature of our data allows us to estimate individual fixed-effects regressions and thereby control for all selection on time-invariant (un)observables. Upon retirement, individuals spend less on ready-made-food, fuel, and clothes and more in pharmacies, which is consistent with reductions in work-related expenses and increases in health spending. However, individuals also spend less on other consumption categories, such as sports and activities and fine dining. Furthermore, we are in a unique position to document the effect of retirement on credit-card, checking, and savings account balances: we find that individuals deliver by reducing consumer debt and increasing liquid savings. These findings cannot be rationalized via work-related expenses. Any rational agent would save before retirement, the expected fall in income, and dissave after retirement rather than the exact opposite.



Wealth, Debt and Macroeconomic Stability
Title: Wealth, Debt and Macroeconomic Stability

Participants: Henrik Yde Andersen (ECON, CBS and Danmarks Nationalbank) and Niels Lynggård Hansen (ECON, CBS)

Description: TBA
What’s the expected return on stocks over the next decade?(completed)
Title: PDF icon What’s the expected return on stocks over the next decade?

Participant: Jesper Rangvid (FI, CBS)

Description: I consider methods to forecast stock returns over longer horizons, such as ten years, and I evaluate which methods seem more promising. I present estimates of what we should expect stocks to return over the next decade. News is sad: Stock returns over the next decade are expected to be considerably lower than historical returns. I discuss implications for long-term investors, such as pension funds.


The page was last edited by: Department of Finance // 09/15/2022