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Managing Capital Market and Longevity Risks in a Defined Benefit Pension Plan

Authors

  • Samuel H. Cox,

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    • Samuel H. Cox is the L. A. H. Warren Chair Professor at the Asper School of Business, University of Manitoba. Yijia Lin is in the Department of Finance, College of Business Administration, University of Nebraska–Lincoln. Ruilin Tian is in the Department of Accounting, Finance, and Information System, College of Business, North Dakota State University. Jifeng Yu is in the Department of Management, College of Business Administration, University of Nebraska–Lincoln. The second author can be contacted via e-mail: yijialin@unl.edu. This article was presented at the seventh International Longevity Risk and Capital Market Solutions Symposium in Frankfurt, Germany, in September 2011. The authors appreciate helpful comments from the participants at the meeting. The authors also thank the associate editor and the two anonymous referees for their very helpful suggestions and comments during the revision process.
  • Yijia Lin,

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    • Samuel H. Cox is the L. A. H. Warren Chair Professor at the Asper School of Business, University of Manitoba. Yijia Lin is in the Department of Finance, College of Business Administration, University of Nebraska–Lincoln. Ruilin Tian is in the Department of Accounting, Finance, and Information System, College of Business, North Dakota State University. Jifeng Yu is in the Department of Management, College of Business Administration, University of Nebraska–Lincoln. The second author can be contacted via e-mail: yijialin@unl.edu. This article was presented at the seventh International Longevity Risk and Capital Market Solutions Symposium in Frankfurt, Germany, in September 2011. The authors appreciate helpful comments from the participants at the meeting. The authors also thank the associate editor and the two anonymous referees for their very helpful suggestions and comments during the revision process.
  • Ruilin Tian,

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    • Samuel H. Cox is the L. A. H. Warren Chair Professor at the Asper School of Business, University of Manitoba. Yijia Lin is in the Department of Finance, College of Business Administration, University of Nebraska–Lincoln. Ruilin Tian is in the Department of Accounting, Finance, and Information System, College of Business, North Dakota State University. Jifeng Yu is in the Department of Management, College of Business Administration, University of Nebraska–Lincoln. The second author can be contacted via e-mail: yijialin@unl.edu. This article was presented at the seventh International Longevity Risk and Capital Market Solutions Symposium in Frankfurt, Germany, in September 2011. The authors appreciate helpful comments from the participants at the meeting. The authors also thank the associate editor and the two anonymous referees for their very helpful suggestions and comments during the revision process.
  • Jifeng Yu

    Search for more papers by this author
    • Samuel H. Cox is the L. A. H. Warren Chair Professor at the Asper School of Business, University of Manitoba. Yijia Lin is in the Department of Finance, College of Business Administration, University of Nebraska–Lincoln. Ruilin Tian is in the Department of Accounting, Finance, and Information System, College of Business, North Dakota State University. Jifeng Yu is in the Department of Management, College of Business Administration, University of Nebraska–Lincoln. The second author can be contacted via e-mail: yijialin@unl.edu. This article was presented at the seventh International Longevity Risk and Capital Market Solutions Symposium in Frankfurt, Germany, in September 2011. The authors appreciate helpful comments from the participants at the meeting. The authors also thank the associate editor and the two anonymous referees for their very helpful suggestions and comments during the revision process.

ABSTRACT

This article proposes a model for a defined benefit pension plan to minimize total funding variation while controlling expected total pension cost and funding downside risk throughout the life of a pension cohort. With this setup, we first investigate the plan's optimal contribution and asset allocation strategies, given the projection of stochastic asset returns and random mortality evolutions. To manage longevity risk, the plan can use either the ground-up hedging strategy or the excess-risk hedging strategy. Our numerical examples demonstrate that the plan transfers more unexpected longevity risk with the excess-risk strategy due to its lower total hedge cost and more attractive structure.

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