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Portfolio Choice and Benchmarking: The Case of the Unemployment Insurance Fund in Chile

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  • Castaneda, Pablo

Abstract

A new Unemployment Insurance System based on individual accounts was launched in Chile on October 2002. One of the most interesting features of the system is given by the compensation scheme of the fund manager, which contains a performance based incentive benchmarked to one of the default portfolios of the pension system (pension funds Type E, with a 100% investment in fixed-income securities). This paper studies the portfolio choice problem of a fund manager which is subject to a similar performance-based compensation scheme. We model the portfolio choice problem of a risk averse portfolio manager that must finance an exogenous sequence of benefits, and whose terminal payoff depends upon the terminal value of the portfolio under management, relative to an exogenous benchmark portfolio. Our interest is on the consequences of the incentive scheme over the portfolio that is selected by the portfolio manager. For the Black and Scholes [1973] economy we are able to determine the investment policy in closed form. We show that the riskiness of the portfolio depends on the composition of the benchmark, and that the fund manager is motivated to imitate the investment policy of the benchmark in some random scenarios.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 3346.

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Date of creation: 30 Sep 2005
Date of revision: 30 Dec 2006
Handle: RePEc:pra:mprapa:3346

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Keywords: Benchmark portfolio; Individual accounts; Portfolio choice; Unemployment Insurance;

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  1. Cox, John C. & Huang, Chi-fu, 1989. "Optimal consumption and portfolio policies when asset prices follow a diffusion process," Journal of Economic Theory, Elsevier, Elsevier, vol. 49(1), pages 33-83, October.
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  5. Basak, Suleyman & Pavlova, Anna & Shapiro, Alex, 2003. "Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4303-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  7. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, Elsevier, vol. 3(4), pages 373-413, December.
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  10. Jérôme B. Detemple & René Garcia & Marcel Rindisbacher, 2000. "A Monte-Carlo Method for Optimal Portfolios," CIRANO Working Papers, CIRANO 2000s-05, CIRANO.
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  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  13. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  14. Jennifer Carpenter, 1999. "Does Option Compensation Increase Managerial Risk Appetite?," New York University, Leonard N. Stern School Finance Department Working Paper Seires, New York University, Leonard N. Stern School of Business- 99-076, New York University, Leonard N. Stern School of Business-.
  15. Jennifer N. Carpenter, 2000. "Does Option Compensation Increase Managerial Risk Appetite?," Journal of Finance, American Finance Association, American Finance Association, vol. 55(5), pages 2311-2331, October.
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