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Emerging Market Pension Funds and International Diversification

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  • Wade D. Pfau

    (National Graduate Institute for Policy Studies)

Abstract

Many countries are currently increasing the advanced funding of their public pension systems to improve their sustainability in the face of rapidly aging populations. When pensions are funded, the issue of asset allocation becomes of paramount importance. Through compound interest, the rate of growth for pension fund assets will have enormous implications for the level of pension contributions that will be needed to fund a desired level of benefits. Standard portfolio selection theory provides a fundamental justification for international diversification: by widening the pool of potential assets, investors can potentially increase returns while possibly even reducing risks through the selection of complementary assets with low correlations. Nonetheless, many emerging market countries have regulations that strictly limit the choice of investments for pension funds, in some cases excluding international assets entirely. This paper seeks to determine what economic theory suggests is the optimal asset allocation for public pension systems in emerging market countries, and in particular, what role international assets play in the optimal portfolios. We find that on average, about half of the portfolios of emerging market countries should be in world assets. The paper then quantifies the costs of prohibiting international diversification.

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Bibliographic Info

Paper provided by National Graduate Institute for Policy Studies in its series GRIPS Discussion Papers with number 08-10.

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Length: 18 pages
Date of creation: Sep 2008
Date of revision:
Handle: RePEc:ngi:dpaper:08-10

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  1. Jorge A. Chan-Lau, 2004. "Pension Funds and Emerging Markets," IMF Working Papers 04/181, International Monetary Fund.
  2. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
  3. Reisen, Helmut, 1997. "Liberalizing foreign investments by pension funds: Positive and normative aspects," World Development, Elsevier, vol. 25(7), pages 1173-1182, July.
  4. World Bank, 2007. "World Development Indicators 2007," World Bank Publications, The World Bank, number 8150, October.
  5. Davis, E. Philip, 2002. "Prudent person rules or quantitative restrictions? The regulation of long-term institutional investors' portfolios," Journal of Pension Economics and Finance, Cambridge University Press, vol. 1(02), pages 157-191, July.
  6. Bodie, Zvi & Merton, Robert C., 2002. "International pension swaps," Journal of Pension Economics and Finance, Cambridge University Press, vol. 1(01), pages 77-83, March.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Gary Burtless, 2007. "International Investment for Retirement Savers: Historical Evidence on Risk and Returns," Working Papers, Center for Retirement Research at Boston College wp2007-05, Center for Retirement Research, revised Feb 2007.
  9. Blake, David, 2000. "Does It Matter What Type of Pension Scheme You Have?," Economic Journal, Royal Economic Society, vol. 110(461), pages F46-81, February.
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Cited by:
  1. Hearn, Bruce, 2013. "Size and liquidity effects in Nigeria: an industrial sector study," MPRA Paper 47975, University Library of Munich, Germany.
  2. Kariastanto, Bayu, 2011. "Should the Indonesian pension funds invest abroad?," MPRA Paper 33581, University Library of Munich, Germany.
  3. Ajantha Kumara & Wade Pfau, 2013. "Would emerging market pension funds benefit from international diversification: investigating wealth accumulations for pension participants," Annals of Finance, Springer, vol. 9(3), pages 319-335, August.
  4. Du, Wenxin & Schreger, Jesse, 2013. "Local Currency Sovereign Risk," International Finance Discussion Papers 1094, Board of Governors of the Federal Reserve System (U.S.).

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