COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1259

Peter Diamond and John Geanakoplos

June 2000

This paper explores the general equilibrium impact of social security portfolio diversification into private securities, either through the trust fund or via private accounts. The analysis depends critically on heterogeneity in saving, in production, in assets, and in taxes. Under fairly general assumptions we show that limited diversification increases a neutral social welfare function, increases interest rates, reduces the expected return on short-term equity (and thus the equity premium), decreases safe investment and increases risky investment. However, the effect on aggregate investment, long-term capital values, and the utility of young savers hinges on delicate assumptions about technology. Aggregate investment and long-term asset values often move in the opposite direction. Thus social security diversification might reduce long-term equity value while it increases aggregate investment.

Keywords: Private accounts, trust fund, diversification, heterogeneity, overlapping generations

JEL Classification: D50, D60, D91, G11, G28, H55