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Optimal Asset Allocation in Asset Liability Management

  • Jules H. van Binsbergen
  • Michael W. Brandt

We study the impact of regulations on the investment decisions of a defined benefits pension plan. We assess the influence of ex ante (preventive) and ex post (punitive) risk constraints on the gains to dynamic, as opposed to myopic, decision making. We find that preventive measures, such as Value-at-Risk constraints, tend to decrease the gains to dynamic investment. In contrast, punitive constraints, such as mandatory additional contributions from the sponsor when the plan becomes underfunded, lead to very large utility gains from solving the dynamic program. We also show that financial reporting rules have real effects on investment behavior. For example, the current requirement to discount liabilities at a rolling average of yields, as opposed to at current yields, induces grossly suboptimal investment decisions.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12970.

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Date of creation: Mar 2007
Date of revision:
Handle: RePEc:nbr:nberwo:12970
Note: AP
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