Intergenerational Risk Trading and the Innovative Role of Equity- Wage Swaps

From a life cycle theory perspective, both young and old individuals may gain from a reallocation of equity and wage risk exposure between each other. However, current financial markets do not offer wage growth-linked securities and borrowing against labor income without collateral is difficult. To improve intergenerational risk reallocation, we propose a market-based voluntary risk trading arrangement between coexisting generations via an innovative swap market where participants trade equity-related returns for wage-linked returns, and vice versa. The maturity of the swap contract is restricted to one year to address the collateral issue. We find there is
always a market for equity–wage swaps and the market-clearing premium will vary depending on multiple state variables (economy, demographics, and human and financial capital). This innovative swap market is effective at improving the welfare of all generations because the trading of wagelinked returns leads to a more complete market, enabling individuals to realize a more preferred risk exposure over their life cycles.
JEL classification: D52; G11; G23.
Keywords: Intergenerational Risk Trading; Equity-wage Swap Market; Wage-linked Claims; Incomplete Market; Equilibrium Pricing.