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Optimal portfolio allocation for corporate pension funds

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  • McCarthy, David
  • Miles, David K

Abstract

We model the asset allocation decision of a stylized corporate defined benefit pension plan in the presence of hedgeable and unhedgeable risks. We assume that plan fiduciaries--who make the asset allocation decision--face non-linear payoffs linked to the plan’s funding status because of the presence of pension insurance and a sponsoring employer who may share any shortfall or pension surplus. We find that even simple asymmetries in payoffs have large and highly persistent effects on asset allocation, while unhedgeable risks exert only a small effect. We conclude that institutional details are crucial in understanding DB pension asset allocation.

Suggested Citation

  • McCarthy, David & Miles, David K, 2011. "Optimal portfolio allocation for corporate pension funds," CEPR Discussion Papers 8198, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8198
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    References listed on IDEAS

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    1. Andreas Graflund & Birger Nilsson, 2003. "Dynamic Portfolio Selection: the Relevance of Switching Regimes and Investment Horizon," European Financial Management, European Financial Management Association, vol. 9(2), pages 179-200.
    2. Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, vol. 32(2), pages 627-638, May.
    3. Exley, C.J. & Mehta, S.J.B. & Smith, A.D., 1997. "The Financial Theory of Defined Benefit Pension Schemes," British Actuarial Journal, Cambridge University Press, vol. 3(04), pages 835-966, October.
    4. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    5. Marcus, Alan J, 1985. " Spinoff-Terminations and the Value of Pension Insurance," Journal of Finance, American Finance Association, vol. 40(3), pages 911-924, July.
    6. Roel M. W. J. Beetsma & A. Lans Bovenberg, 2009. "Pensions and Intergenerational Risk-sharing in General Equilibrium," Economica, London School of Economics and Political Science, vol. 76(302), pages 364-386, April.
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    Cited by:

    1. 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(04), pages 501-525, October.

    More about this item

    Keywords

    corporate balance sheets; pension funds; portfolio allocation;

    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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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