Template-Type: ReDIF-Paper 1.0
Author-Name: Carsten Krabbe Nielsen
Author-X-Name-First: Carsten 
Author-X-Name-Last:  Nielsen

Author-Email: carsten.nielsen@unicatt.it
Author-Workplace-Name: Università Cattolica del Sacro Cuore
Author-Workplace-Name: Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore


Title: Rational Overconfidence and Social Security
Abstract: Is an assumption of bounded rationality needed to explain Social Security and other mandatory
pension plans? In this contribution we argue that when rational agents hold inconsistent expectations such
programs may be justified.
Two of the features that distinguish Social Security and many other state mandated pension plans around
the world are that (i) a minimum level of savings for retirement is imposed on most citizens and (ii) individuals
cannot freely decide how their contributions are invested. Here, a rationale for these two features, based on
rational overconfidence, is proposed. Rational overconfidence is present when equally informed agents hold
diverse confident, rational beliefs. The fact that beliefs are diverse means that all of them cannot be correct,
hence seen as a collective agents do not act optimally.
In the face of rational overconfidence, Pareto efficiency is no longer the natural criterion for comparing
policies and we suggest ex-post welfare optimality in stead. This criterion makes amends for the possible
inconsistencies of agents' beliefs.
Our results on social security are based on a methodology that places itself strictly between the traditional
neoclassical approach and that championed by behavioral economics. This methodology does not deviate from
the neoclassical assumption of rationality but only broadens it and can therefore readily be applied to many
public policy issues.
Length: 30
Creation-Date: 2014-12
File-URL: http://dipartimenti.unicatt.it/economia-finanza-def021.pdf
File-Format: Application/pdf
File-Function: First version, 2014
Number: def021
Classification-JEL: D01, D02, D63, D81, D84, H55. 
Keywords: Subjective Expectations, Rational Beliefs, Ex-post Welfare Optimality, Social Security, Rational
Overconfidence, Portfolio Choice
Handle: RePEc:ctc:serie1:def021