Keywords
Financial Market Development, Pension Reform, Coordination Failure, Game Theory, Portfolio Choice
Abstract
Why do domestic stock markets in many emerging market economies fail to develop, even in the presence of high savings rates? In this paper, we argue that this may be a ‘chicken-and-egg’ problem, which we formalise as a market coordination failure. We first develop a stylised game-theoretical model, showing that when long-term equity investment is subject to network externalities, the Pareto-optimal, high-investment equilibrium is not robust to noise. Individual investors, fearing defection by others, will rationally choose a low-investment (or ‘run’) strategy, trapping the market in a state of underdevelopment. We then show how a specific institutional design – a fully-funded, individually-owned, collectively-managed, mandatory/incentivised (FICMI) pension scheme – can act as a credible coordination device and explore the welfare implications in a tractable three-period model. By providing a guaranteed, patient source of capital, FICMI changes investor expectations and makes the highinvestment, high-welfare equilibrium robust and achievable. This paper provides a new theoretical justification for funded pension systems, not as a tool to correct individual myopia, but as a public-finance institution designed to solve a collective action problem in financial market development.
Acknowledgments
We are grateful for the very helpful discussions with Pablo Antolin (OECD), Tobias Adrian (all from the IMF, unless otherwise stated), Serkan Arslanalp, Nicholas Barr (LSE), Alberto Bisin (NYU), Helge Berger, Nina Budina, Andi Chen (Tsinghua University), Jack Chen, Stephan Danninger, Christopher Evans, Csaba Feher, Vitor Gaspar, Dan Greenwald (NYU Stern), Lei Guang (UCSD), Yueling Huang, Oscar Jorda (UC Davis), Divya Kirti, Vladimir Klyuev, Daniel Leigh, Oana Luca, Koshy Mathai, Mico Mrkaic, Masahiro Nozaki, Stephanie Payet (OECD), Ceyla Pazarbasioglu, Dmitry Plotnikov, Alessandro Rebucci (Johns Hopkins University), Bowen Shi (Central University of Finance and Economics), Mauricio Soto, Fiona Stewart (World Bank), Eddy Tam (King’s College London), Rodrigo Valdes, Tao Wang (Hong Kong University), Shang-Jin Wei (Columbia University), Wentao Xiong, Bingwen Zheng (Chinese Academy of Social Sciences), Tianxiao Zheng, the IMF China team in August 2023, and especially with Romain Despalins (OECD) and Boele Bonthuis.
The views expressed here are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
This research was originally developed as an IMF Working Paper, and an earlier version of this paper was published as an IMF Working Paper 25/49 (modeling section).
Funding
The research received no funds.
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship, and publication of the article.
Declaration about the scope of AI utilisation
The authors did not use an AI tool in the preparation of the article.
Recommended Citation
Khan, S., Li, B., & Zhao, Y. (2026). Addressing the ‘Chicken-and-Egg’ Dilemma: Pension Reform, Market Coordination, and Policy Design. Journal of Banking and Financial Economics, 2026(1), 50-30. https://doi.org/10.7172/2353-6845.jbfe.2026.1.4
First Page
50
Last Page
30
Page Count
18
Received Date
14.11.2025
Revised Date
13.04.2026
Accept Date
08.06.2026
Online Available Date
10.07.2026
DOI
10.7172/2353-6845.jbfe.2026.1.4
JEL Code
G23, G20, H55, O16, D71
Publisher
University of Warsaw
