Foreign equity investment in Uruguayan pension funds

This paper is a preliminary application of portfolio theories based on traditional (variance) and modern (Value at risk-VaR) measures of risk to determine the optimal participation of foreign equity investment in the Uruguayan pension funds industry on the basis of 1997-2000 asset return data. We address here an important public policy question, for foreign investment is restricted by regulation, and domestic equity market is practically non-existent. Our emphasis is on sector performance evaluation and indirect regulatory cost assessment. We find that optimal portfolios are highly polarized in two asset bundles whose expected returns and volatilities are in the opposite extremes. Although in the lower and of portfolio returns the "home bias" is remerkably strong, there is room for return enhancement by allowing a small shara of foreign equity investment. These results are robust to different empirical and normal shocks distribution assumptions. The extent of the home bias suggests a good performance and low regulatory costs. However, we point out the role of the non-modeled small probability but highly damaging events in the policy interpretation of our conclusions.