The Optimal Portfolio Allocation for Corporate Pension Funds

41 Pages Posted: 1 Aug 2009

See all articles by David McCarthy

David McCarthy

Imperial College Business School

David Miles

Imperial College Business School; The Bank of England; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: July 29, 2009

Abstract

We model the asset allocation decision of a stylized corporate defined benefit pension fund. Besides including an allowance for uncertainty both of the future value of assets (because of uncertain investment returns) and liabilities (because of uncertainty in future longevity and in future interest rates), the key feature of our model is that asset allocation decisions are made by fiduciaries who face payoffs that are linked in an indirect way to the value of the underlying assets. This is because of the presence of pension insurance and a sponsoring employer who may make good any shortfall in assets, and who may reclaim some pension surplus. We find that even simple asymmetries in payoffs have large effects on asset allocation which are highly persistent over time in a dynamic framework. In contrast with models of pension asset allocation that ignore these factors, we are able to substantially replicate observed DB pension asset allocations in the UK and US. We conclude that institutional details - in particular asymmetries in payoffs to pension fiduciaries - are crucial in understanding DB pension asset allocation.

Keywords: agency cost, corporate pensions, asset allocation

JEL Classification: G20, G23, J32

Suggested Citation

McCarthy, David and Miles, David Kenneth, The Optimal Portfolio Allocation for Corporate Pension Funds (July 29, 2009). Available at SSRN: https://ssrn.com/abstract=1440872 or http://dx.doi.org/10.2139/ssrn.1440872

David McCarthy (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

David Kenneth Miles

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

The Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany