The equity risk premium and pension ambition: The effect of parameter uncertainty

  • Alexander de Roode Alexander de Roode

We model uncertainty of financial parameters and examine its impact on the replacement rate in a DC pension contract. To this end, we develop a novel Bayesian framework that reveals substantial reduction in the lower percentiles for the replacement rate at retirement. Weidentify that the key factor driving our results is the uncertainty of the equity risk premium.Our model shows that a time-varying contribution scheme based on observed interest rates and previous equity return can partially compensate for the effect of parameter uncertainty.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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