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Emerging Market Pension Funds and International Diversification

Author

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  • Wade D. Pfau

    (National Graduate Institute for Policy Studies, Japan)

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.

Suggested Citation

  • Wade D. Pfau, 2011. "Emerging Market Pension Funds and International Diversification," Journal of Developing Areas, Tennessee State University, College of Business, vol. 45(1), pages 1-17, July-Dece.
    • Handle: RePEc:jda:journl:vol.45:year:2011:issue1:pp:1-17
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    File URL: http://muse.jhu.edu/journals/journal_of_developing_areas/v045/45.pfau.html
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    Citations

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    Cited by:

    1. 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.
    2. Kariastanto, Bayu, 2011. "Should the Indonesian pension funds invest abroad?," MPRA Paper 33581, University Library of Munich, Germany.
    3. Wenxin Du & Jesse Schreger, 2016. "Local Currency Sovereign Risk," Journal of Finance, American Finance Association, vol. 71(3), pages 1027-1070, June.
    4. Gudjonsson Jon & Hougaard Jensen Svend E., 2023. "Pension Funds and Financial Stability: The Case of the UK Gilt Crisis," Intereconomics: Review of European Economic Policy, Sciendo, vol. 58(3), pages 155-159, June.

    More about this item

    Keywords

    asset allocation; emerging markets; pensions; international diversification;
    All these keywords.

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • 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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