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Optimal investment policies for defined benefit pension funds

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  • SIEGMANN, ARJEN

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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Suggested Citation

  • Siegmann, Arjen, 2007. "Optimal investment policies for defined benefit pension funds," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(01), pages 1-20, March.
  • Handle: RePEc:cup:jpenef:v:6:y:2007:i:01:p:1-20_00
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    1. 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.
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    4. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
    5. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    6. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
    7. Randall S. Hiller & Jonathan Eckstein, 1993. "Stochastic Dedication: Designing Fixed Income Portfolios Using Massively Parallel Benders Decomposition," Management Science, INFORMS, pages 1422-1438.
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    Cited by:

    1. Liu, Shuangzhe & Ma, Tiefeng & Polasek, Wolfgang, 2014. "Spatial system estimators for panel models: A sensitivity and simulation study," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 101(C), pages 78-102.
    2. Hans Fehr & Christian Habermann, 2008. "Risk Sharing and Efficiency Implications of Progressive Pension Arrangements," Scandinavian Journal of Economics, Wiley Blackwell, pages 419-443.
    3. Arjen Siegmann, 2008. "Minimum Funding Ratios for Defined-Benefit Pension Funds," DNB Working Papers 180, Netherlands Central Bank, Research Department.
    4. Ines Fortin & Jaroslava Hlouskova, 2015. "Downside loss aversion: Winner or loser?," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 81(2), pages 181-233, April.
    5. Fortin, Ines & Hlouskova, Jaroslava, 2012. "Optimal Asset Allocation under Quadratic Loss Aversion," Economics Series 291, Institute for Advanced Studies.
    6. Siegmann, Arjen, 2011. "Minimum funding ratios for defined-benefit pension funds," Journal of Pension Economics and Finance, Cambridge University Press, pages 417-434.

    More about this item

    JEL classification:

    • 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

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