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Emerging Market Pension Funds and International Diversification

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  • Pfau, Wade Donald

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. 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 uses modern portfolio theory to determine the optimal asset allocation for public pension systems in emerging market countries. 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 University Library of Munich, Germany in its series MPRA Paper with number 19039.

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Date of creation: Jun 2009
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Handle: RePEc:pra:mprapa:19039

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Keywords: emerging markets; asset allocation; pensions; defined-contribution;

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References

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  1. 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.
  2. World Bank, 2007. "World Development Indicators 2007," World Bank Publications, The World Bank, number 8150, October.
  3. 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.
  4. 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.
  5. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  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. 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.
  8. Helmut Reisen, 1997. "Liberalising Foreign Investments by Pension Funds: Positive and Normative Aspects," OECD Development Centre Working Papers 120, OECD Publishing.
  9. Jorge A. Chan-Lau, 2004. "Pension Funds and Emerging Markets," IMF Working Papers 04/181, International Monetary Fund.
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Cited by:
  1. Kumara, Ajantha Sisira & Pfau, Wade Donald, 2011. "Would emerging market pension funds benefit from international diversification: investigating wealth accumulations for pension participants," MPRA Paper 31395, University Library of Munich, Germany, revised 10 Jun 2011.
  2. Hearn, Bruce, 2013. "Size and liquidity effects in Nigeria: an industrial sector study," MPRA Paper 47975, University Library of Munich, Germany.
  3. Kariastanto, Bayu, 2011. "Should the Indonesian pension funds invest abroad?," MPRA Paper 33581, University Library of Munich, Germany.
  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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