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Optimal Investment Policies for Defined Benefit Pension Funds

  • A.H. Siegmann

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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File URL: http://www.dnb.nl/binaries/wo0728_tcm46-146019.pdf
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Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 728.

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Date of creation: 2003
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Handle: RePEc:dnb:wormem:728
Contact details of provider: Postal: Postbus 98, 1000 AB Amsterdam
Web page: http://www.dnb.nl/en/

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  1. Shlomo Benartzi & Richard H. Thaler, 1993. "Myopic Loss Aversion and the Equity Premium Puzzle," NBER Working Papers 4369, National Bureau of Economic Research, Inc.
  2. 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.
  3. Hirshleifer, David, 2001. "Investor Psychology and Asset Pricing," MPRA Paper 5300, University Library of Munich, Germany.
  4. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, March.
  5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  6. 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.
  7. 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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