Financial Demography: How Population Aging Affects Financial Markets

Financial demography analyzes effects of demographic change in general, and population ageing in particular, on financial markets. These effects are multiple and complex. This chapter reviews the academic literature focusing on three key areas: long-term real interest rates, equity markets, and pension systems. The impact of an ageing population on long-term real interest rates is ambiguous. While lower savings due to the retirement of baby boomers put upward pressure on interest rates, increasing scarcity of labor pushes real interest rates down. Population ageing affects equity markets in four major ways: (1) stock market participation, (2) relative demand for shares of companies active in particular industries, (3) risk aversion and risk premia, and (4) the demand for dividend yielding stocks. Both main types of pension systems – pay-as-you-go and fully funded systems – are negatively affected by population ageing. Pay-as-you-go systems become unsustainable due to a decrease in the number of contributors relative to the number of recipients. Fully funded systems rely on asset market returns. If asset market returns in an ageing society fall due to baby boomers selling their stocks and real estate, the sustainability of “fully funded” systems is at stake as well. These observations highlight the importance of international capital mobility: The capital stock of ageing societies should be invested where the return on capital remains high, i.e., in countries with younger populations. To conclude, sustainable financial markets cannot afford to ignore demography