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Optimal Investment Policies for Defined Benefit Pension Funds

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  • Arjen Siegmann

Abstract

This paper analyzes optimal investment policies for pension funds of a defined benefit (DB) type. The nature of a DB fund induces a natural modeling of preferences being of the mean-downside risk type. With compensation for inflation as an explicit goal of a pension fund, a natural reference point for the risk measure is the real or indexed value of the liabilities. Results are presented for a mean-shortfall model and different assumptions for inflation uncertainty, correlation between inflation and stock returns, and the level of the risk-free rate. Comparative statics show increased risk-taking for funding ratios moving away from the reference point. We provide intuition for the results and compare the outcomes with actual investment policies of six large Dutch pension funds.

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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 112.

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Length: 33 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:dnb:staffs:112

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Keywords: pension funds; optimal investments; defined benefit;

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  1. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  2. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, 08.
  3. Randall S. Hiller & Jonathan Eckstein, 1993. "Stochastic Dedication: Designing Fixed Income Portfolios Using Massively Parallel Benders Decomposition," Management Science, INFORMS, vol. 39(11), pages 1422-1438, November.
  4. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  5. Zenios, Stavros A. & Holmer, Martin R. & McKendall, Raymond & Vassiadou-Zeniou, Christiana, 1998. "Dynamic models for fixed-income portfolio management under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 22(10), pages 1517-1541, August.
  6. Maranas, C. D. & Androulakis, I. P. & Floudas, C. A. & Berger, A. J. & Mulvey, J. M., 1997. "Solving long-term financial planning problems via global optimization," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1405-1425, June.
  7. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, Octomber.
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Cited by:
  1. Shuangzhe Liu & Tiefeng Ma & Wolfgang Polasek, 2012. "Spatial System Estimators for Panel Models: A Sensitivity and Simulation Study," Working Paper Series 75_12, The Rimini Centre for Economic Analysis.
  2. Siegmann, Arjen, 2011. "Minimum funding ratios for defined-benefit pension funds," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(03), pages 417-434, July.
  3. Peter Vlaar, 2005. "Defined Benefit Pension Plans and Regulation," DNB Working Papers 063, Netherlands Central Bank, Research Department.
  4. Fortin, Ines & Hlouskova, Jaroslava, 2012. "Optimal Asset Allocation under Quadratic Loss Aversion," Economics Series 291, Institute for Advanced Studies.

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