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Pension Funds and Financial Innovation

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  • Zvi Bodie

Abstract

Pension funds have played a critical role in the evolution of the markets for debt and equity securities and their derivatives in the U.S. over the last 15 years. The new securities and markets can largely be explained as responses to the investment demands of pension funds in an environment of increased interest rate volatility and tighter regulation. Defined benefit pension plans offer annuities that have a guaranteed floor specified by the benefit formula. In order to minimize the cost to the sponsor of providing this guarantee, there is a strong incentive to invest an amount equal to the present value of the accumulated benefit obligation in fixed- income securities with a matching duration. The pursuit of duration matching and related immunization strategies by pension funds has contributed to the emergence and rapid growth of markets for zero coupon bonds, GIC's, CMO's, options, and financial futures contracts. Recent changes in accounting rules (FAS 87) and tax law (OBRA) are likely to reinforce the use of immunization strategies.

Suggested Citation

  • Zvi Bodie, 1989. "Pension Funds and Financial Innovation," NBER Working Papers 3101, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3101
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    References listed on IDEAS

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    1. Benjamin M. Friedman, 1983. "Pension Funding, Pension Asset Allocation, and Corporate Finance: Evidence from Individual Company Data," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 107-152 National Bureau of Economic Research, Inc.
    2. Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1987. "How Does the Market Value Unfunded Pension Liabilities?," NBER Chapters,in: Issues in Pension Economics, pages 81-110 National Bureau of Economic Research, Inc.
    3. J. Michael Harrison & William F. Sharpe, 1983. "Optimal Funding and Asset Allocation Rules for Defined-Benefit Pension Plans," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 91-106 National Bureau of Economic Research, Inc.
    4. Langetieg, T. C. & Findlay, M. C. & da Motta, L. F. J., 1982. "Multiperiod Pension Plans and ERISA," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(04), pages 603-631, November.
    5. Martin Feldstein, 1983. "Should Private Pensions Be Indexed?," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 211-230 National Bureau of Economic Research, Inc.
    6. Modigliani, Franco. & Cohn, Richard A., 1984. "Inflation and corporate financial management," Working papers 1572-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    7. Ross, Stephen A, 1989. " Institutional Markets, Financial Marketing, and Financial Innovation," Journal of Finance, American Finance Association, vol. 44(3), pages 541-556, July.
    8. Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, vol. 32(2), pages 627-638, May.
    9. Jeremy I. Bulow, 1982. "What are Corporate Pension Liabilities?," The Quarterly Journal of Economics, Oxford University Press, vol. 97(3), pages 435-452.
    10. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    11. Mitchell A. Petersen, 1992. "Pension Reversions and Worker-Stockholder Wealth Transfers," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 1033-1056.
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    Cited by:

    1. Thomas Crossley & Mario Jametti, 2013. "Pension Benefit Insurance and Pension Plan Portfolio Choice," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 337-341, March.
    2. Vittas, Dimitri, 2000. "Pension reform and capital market development -"feasibility"and"impact"preconditions," Policy Research Working Paper Series 2414, The World Bank.
    3. Warren Tease & Jenny Wilkinson, 1993. "The Provision of Financial Services – Trends, Prospects and Implications," RBA Research Discussion Papers rdp9315, Reserve Bank of Australia.
    4. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.
    5. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.
    6. Vittas, Dimitri, 1998. "Institutional investors and securities markets : which comes first?," Policy Research Working Paper Series 2032, The World Bank.
    7. Vittas, Dimitri & Michelitsch, Roland, 1995. "Pension funds in Central Europe and Russia : their prospects and potential role in corporate governance," Policy Research Working Paper Series 1459, The World Bank.

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