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Optimal Portfolio Allocation for Corporate Pension Funds

Authors


  • The authors would like to thank an anonymous referee, whose comments greatly improved the paper, as well as Francis Breedon, Andrea Buraschi, John Campbell, participants at the Imperial College Finance Workshop, and the Warwick Conference on Pension Funds for their comments and suggestions on the paper. Simon Burbidge at the Imperial College High Performance Computing Centre was also very helpful. All remaining errors are our own. The views in the paper in no way represent those of the Bank of England. Correspondence: David McCarthy

Abstract

We model the asset allocation decision of a stylised 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.

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