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Optimal investment policies for defined benefit pension funds

  • SIEGMANN, ARJEN

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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Article provided by Cambridge University Press in its journal Journal of Pension Economics and Finance.

Volume (Year): 6 (2007)
Issue (Month): 01 (March)
Pages: 1-20

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Handle: RePEc:cup:jpenef:v:6:y:2007:i:01:p:1-20_00
Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
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  1. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, March.
  2. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  3. 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.
  4. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, 08.
  5. 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.
  6. 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.
  7. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
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