Optimal Portfolio Allocation for Corporate Pension Funds
AbstractWe model the asset allocation decision of a defined benefit pension fund using a stochastic dynamic programming approach. Our model recognizes the fact that asset allocation decisions are made by trustees who are mandated to act in the best interests of beneficiaries - not by sponsoring employers - and that trustees face payoffs that are linked in an indirect way to the value of the underlying assets. This is because of the presence of pension insurance - which may cover a portion of deficits in the event of a sponsor default - and a sponsoring employer who may make good any shortfall in assets, and who may reclaim some pension surplus. Our model includes an allowance for uncertainty both of the future value of assets (because of uncertain investment returns) and liabilities (because of uncertainty in future longevity and in future interest rates). We find that we are able to substantially replicate observed DB pension asset allocations in the UK and conclude that institutional details - in particular asymmetries in payoffs to pension trustees - are crucial in understanding pension asset allocation.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6394.
Date of creation: Jul 2007
Date of revision:
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Other versions of this item:
- McCarthy, David & Miles, David K, 2011. "Optimal portfolio allocation for corporate pension funds," CEPR Discussion Papers 8198, C.E.P.R. Discussion Papers.
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-07-27 (All new papers)
- NEP-CFN-2007-07-27 (Corporate Finance)
- NEP-DGE-2007-07-27 (Dynamic General Equilibrium)
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