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Optimal Portfolio Allocation for Corporate Pension Funds

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  • Miles, David
  • McCarthy, David

Abstract

We model the asset allocation decision of a defined benefit pension fund using a stochastic dynamic programming approach. Our model recognizes the fact that asset allocation decisions are made by trustees who are mandated to act in the best interests of beneficiaries - not by sponsoring employers - and that trustees face payoffs that are linked in an indirect way to the value of the underlying assets. This is because of the presence of pension insurance - which may cover a portion of deficits in the event of a sponsor default - and a sponsoring employer who may make good any shortfall in assets, and who may reclaim some pension surplus. Our model includes an allowance for uncertainty both of the future value of assets (because of uncertain investment returns) and liabilities (because of uncertainty in future longevity and in future interest rates). We find that we are able to substantially replicate observed DB pension asset allocations in the UK and conclude that institutional details - in particular asymmetries in payoffs to pension trustees - are crucial in understanding pension asset allocation.

Suggested Citation

  • Miles, David & McCarthy, David, 2007. "Optimal Portfolio Allocation for Corporate Pension Funds," CEPR Discussion Papers 6394, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:6394
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    Cited by:

    1. Michael A.S. Joyce & Zhuoshi Liu & Ian Tonks, 2017. "Institutional Investors and the QE Portfolio Balance Channel," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(6), pages 1225-1246, September.
    2. Platanakis, Emmanouil & Sutcliffe, Charles, 2016. "Pension scheme redesign and wealth redistribution between the members and sponsor: The USS rule change in October 2011," Insurance: Mathematics and Economics, Elsevier, vol. 69(C), pages 14-28.
    3. Weller, Christian E. & Wenger, Jeffrey B., 2009. "Prudent investors: the asset allocation of public pension plans," Journal of Pension Economics and Finance, Cambridge University Press, vol. 8(4), pages 501-525, October.
    4. Anna Battauz & Alessandro Sbuelz, 2018. "Non†myopic portfolio choice with unpredictable returns: The jump†to†default case," European Financial Management, European Financial Management Association, vol. 24(2), pages 192-208, March.
    5. Douglas, Graeme & Roberts-Sklar, Matt, 2018. "What drives UK defined benefit pension funds' investment behaviour?," Bank of England working papers 757, Bank of England.
    6. Luca Larcher & Francis Breedon, 2020. "Discounting and the market valuation of defined benefit pensions," Working Papers 932, Queen Mary University of London, School of Economics and Finance.
    7. Katarzyna Romaniuk, 2020. "Does surplus/deficit sharing increase risk-taking in a corporate defined benefit pension plan?," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(1), pages 229-249, June.
    8. Daniel Giamouridis & Athanasios Sakkas & Nikolaos Tessaromatis, 2017. "Dynamic Asset Allocation with Liabilities," European Financial Management, European Financial Management Association, vol. 23(2), pages 254-291, March.

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    More about this item

    Keywords

    Pensions; Portfolio allocation; Longevity;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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