The Optimal Portfolio of PAYG Benefits and Funded Pensions in Germany

The combination of a pay-as-you-go (PAYG) and a self-funded pension system is studied from a portfolio perspective considering the trade-off between speculation and hedging. We analyze the German PAYG social security system and subsidized private savings (Riester pension). The return and the risk associated with a combination of both systems are simulated in a stochastic economy. Our results suggest that (1) a risk-minimizing structure of total retirement income still allows a fraction 5 percent to be financed via private savings, due to the benefits of hedging, (2) the optimal portfolio shares at a fixed total pension level imply high fractions of private savings even if agents are highly risk-averse, and (3) determining the optimal size of the total pension level under the current social security system implies only low additional private saving rates.