Is there a relationship between demographic changes and returns on financial assets? Is the baby boomer generation a key factor in the rise in asset values in the 1990s? If so, will the aging and retirement of the baby boom generation cause a meltdown of Asset Prices? What is the relationship between the prime saving years, between the ages of 45 and 60, and the returns on stocks and bonds? Will retirement of the baby boom generation lead to a sudden selling of financial assets? Is this phenomenon restricted to the United States or does it affect other countries? This paper delves into these issues as it tries to analyze the relationship between population adding and financial asset pricing. The research and analysis surrounding this relationship has been varied and often conflicting. Past theoretical evidence has discussed a potential connection between demographic structure and asset returns. However, these assertions have rarely been proven through analysis of historical relationship or confirmed by empirical evidence (Poterba 1998, 2). Using previous studies which investigate this relationship, this paper concludes that in fact the evidence points to a weak relationship between population aging, or demographic change, and asset price patterns.
This paper is divided into five sections. The first section will present
general information about the baby boom generation and their role in population,
demographic, and economic change over the past seventy years. The second
section will take a deeper look at a study that provides empirical evidence
that provides information about the specific relationship between demographic
change and asset price patterns in the United States, Canada, and the United
Kingdom. The third section looks at past research which provides both theoretical
and empirical evidence of the relationships and, further analyzes the problems
with the previous analyses. Also, it discusses the specifics of a study
that assesses the impact the baby boom's asset market effects will have
on Social Security reform in the future. The last section summarizes the
paper.
The Baby Boomers
The baby boomers were born in the two decades following World War II and
were a much larger generation then the preceding and following generations.
The baby boom generation, being much larger than other cohorts, also had
a significant effect on the age structure of the United States Population
(Poterba 1998, 12). Also, the baby boom generation had substantial and important
effects on the U.S. economy. At a young age, this cohort placed pressure
on educational and training infrastructures. Their entrance into the labor
force was associated with an increase in the aggregate unemployment rate
(Poterba 2001, 565). In the 1990s and at the beginning of the twenty-first
century the baby boomers entered into their prime earning years and at the
end of this decade will reach retirement age (Poterba 2001, 565).
Due to their substantial impact on population, age structure, and labor
market, it is easy to understand why researchers have pointed to the baby
boom generation as the main cause for an increase in stock prices and other
asset during the 1990s (Poterba 1998, 1). The baby boomers investment patterns
and portfolio behavior has been a strong contributor to the movement of
the financial markets in the past decade. Specifically, the boomers increased
demand for financial assets along with the group's entry into its key saving
years has been associated with rise in stock prices and market values during
the nineties (Poterba 1998, 1). These assumptions are followed by speculation
that the baby boomer generation will sell these assets in order to fund
their retirement; ultimately, leading to a decline in asset and market value
(Poterba 1998, 1).
Past research analyzing Population Age Structure and Asset Returns
Previous theoretical and empirical studies have pointed to a significant
relationship between demographic change, specifically population aging,
and financial asset prices. However, these past studies have formalized
the logic behind the relationship of population aging and asset pricing
into a simple model (Poterba 2001, 566). This closed economy model places
households into three periods of life, young, middle-aged, and old, in which
a labor of unit is only achieved in the first two periods and each age group
has a fixed demand for financial assets (Poterba 1998, 3). In this model,
an increase in the size of the working cohort will increase the price of
financial assets; yet, the baby boomers are followed by a smaller cohort
of working aged individuals, who are unable to afford these price levels.
This will lead to a decline in asset prices (Poterba 2001, 566). Therefore,
as the larger group, the baby boomers, as they move through the three life
periods, will be followed by a smaller generational group which will lead
to the sale of their high priced assets at a lower price. This will result
in a low return on investments (Poterba 2001, 566). This model shows a significant
negative relationship between population aging and asset pricing, confirming
the potential for an asset price meltdown as the baby boom generation increases
in age and moves towards retirement.
This simple model, however, faces many issues and problems which call its
conclusion into question. Particularly, the model faces opposition for important
logistical problems with asset pricing as well as other problems with results
in increases in capital (Poterba 2002, 566). First, the model fixes the
savings rate rather than using a derivative that will account of endogenous
saving and rational, forward-looking behavior (Poterba 2001, 566). Second,
the model prevents the endogenous production of capital. This results in
the simple model not allowing for forward-looking asset price of capital
goods (Poterba 1998, 5). Third, the simple model takes place in a closed
economy but real markets are part of an open economy which integrated with
other economies and are affected by the world interest rate (Poterba 1998,
4). Last, due to the ability to predict the demographic shifts of the cohort,
there would be no adjustment of asset prices as large cohorts shifted in
age. Therefore, in the simple model the asset price pattern of the baby
Boomer generation can be predicted at birth and are not affected by action
taken in the 1990s (Poterba 1998, 5).
Population Age Structure, Asset Returns, and Social Security Reform of
the Baby Boom
In 1998, Poterba conducted research which looked at new empirical study
that avoids many of the problems with earlier research. The new model considers
the historical relationship between demographic changes, specifically population
aging, and real returns on Treasury bills, long-term government bonds, and
corporate stocks. The spread of assets provided information on returns for
a spectrum of assets from low-volatility to more risky assets (Poterba 1998,
15). The results suggest that there is limited linkage between the demand
variables, demographic change, and returns on the assets (Poterba 1998,
20). There were only two results that were very slightly statistically significant.
First, the effects demographic change had on common stocks suggests that
equity returns will increase with an increase in the median age. Second,
there was a possible link, stronger than that seen between population aging
and stocks, between the returns of the Treasury bill market and demographic
changes (Poterba 2001, 576). Despite the small possibility of correlation,
the general pattern shows a weak, not robust, relationship between demographic
structure and asset returns in the Baby Boomer generation (Poterba 1998,
20). Further, Poterba (2001) provides evidence of data from the United Kingdom
and Canada, which reiterates a weak relationship between demographic changes
and asset returns.
Poterba (1998) suggests three possible reasons for this result. First, there
is a possibility that there is an effect but that it is so small that it
is not detected. Second, the study is limited by the lack of historical
data on demographic structures and asset returns which makes it difficult
to forecast the future relationship between demographic changes and asset
returns (Poterba 1998, 24). Third, this "market meltdown" is unlikely
since equity-holding baby boomers will not sell of their financial assets
suddenly upon retirement (Brooks, 2002). Therefore, the evidence provided
points to a weak relationship between demographic changes and asset returns.
Brooks (2002) looks at the quantitative effect the Baby Boom has on stock
and bond returns. Through the augmentation of a business cycle, the results
show that baby boomers likely earn a lower return on retirement savings
(Brooks, 402). Further, what effect will the baby boom generation have on
government programs such as Social Security and Medicare? Earlier studies
conducted by Bohn (2001) suggests that baby boomers invest in defined benefit
social security as a means of combating the negative wage and asset return
effects associated with retirement (Brooks, 402). However, Brooks' general
model suggests that regardless of this decrease the baby boomers will be
better off in retirement than the generations before them with or without
a defined benefit pension program the size of Social Security and Medicare
(Brooks, 406). Therefore, though Brooks concludes that the baby boomers
will have lower returns on their investment after retirement, these effects
will not be felt because their positioning will be relatively better than
preceding generations.
Conclusion
In conclusion, there is a weak relationship between demographic changes,
specifically population aging, and asset returns. Though pure theoretical
evidence supports a stronger relationship between demographic changes and
asset return, the empirical evidence disproves this relationship. Particularly,
there is a weak relationship between population aging and return on stocks,
Treasury bills, and long-term bonds for those individuals in the baby boom
generation. As one of the larger cohorts in the twentieth century, the baby
boomers have played a crucial role in the development of the labor force
and economy in the United States. This caused concern about a possible "meltdown"
of the financial markets when baby boomers retired and sold their assets
back. However, empirical evidence has shown that the probability of this
is slim due to the weak nature of the quantitative relationship between
demographic changes and asset returns.
Brooks, Robin (2002), "Asset-Market Effects of the Baby Boom and Social-Security Reform", American Economic Review v92, n2 (May 2002): 402-406.
Poterba, James M. (1998), Population Age Structure and Asset Returns: An
Empirical Investigation, National Bureau of Economic Research Working
Paper: 6774 October 1998.
Poterba, James M. (2001), "Demographic Structure and Asset Returns",
Review of Economics and Statistics v83, n4 (November 2001): 565-584.