How Do Individual Accounts Work in the Swedish Pension System?

In 1998, Sweden introduced a second tier of mandatory individual accounts in the public pension system. This paper examinesinvestment choice in the Swedish individual account scheme focusing on two aspects of the investment decision: Do workers with high risk in their human capital diversify their overall portfolio by investing their pension funds in low-risk funds? And to what extent do participants exhibit "home bias" and invest in Swedish assets? Two pieces of evidence support rational investment decisions. First, we establish a positive relationship between income and the level of risk. Second, married participants appear to pool their risks. On the other hand, the results show that participants at the bottom of the income distribution take on as much risk as those at the top, indicating that they are not diversifying their overall portfolio. Finally, participants employed in sectors that are affected by foreign competition are less likely to diversify their portfolios and invest in foreign assets compared to the public sector. Instead, these workers exhibit "home bias" in their investments. (JEL: G11, H55) (c) 2007 by the European Economic Association.