Should Corporate Pensions Invest in Risky Assets? A Risk-sharing Perspective

65 Pages Posted: 12 Nov 2018 Last revised: 5 Nov 2020

See all articles by Wei Li

Wei Li

University of Iowa - Department of Finance

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Jie Ying

Southern Illinois University at Edwardsville - Department of Economics & Finance

Date Written: June 15, 2020

Abstract

We use a modified corporate risk management framework (e.g., Froot and Stein, 1998) to understand how inefficient risk sharing between firms and employees leads to aggressive investment policies of defined corporate pensions as well as their declining popularity. For reasonable parameter values, our model matches key empirical patterns including pension’s risk allocation and the relations among pension investment risk, corporate bankruptcy probability, and pension funding. Further, we show that inefficient risk sharing may cause pensions to invest more aggressively than what employees choose for DC plans. By switching from DB plans to DC plans, firms may substantially reduce pension funding costs.

Keywords: Defined-benefit corporate pensions; asset allocation; external financing cost; systematic risk sharing

JEL Classification: G11, G30, G32

Suggested Citation

Li, Wei and Yao, Tong and Ying, Jie, Should Corporate Pensions Invest in Risky Assets? A Risk-sharing Perspective (June 15, 2020). Available at SSRN: https://ssrn.com/abstract=3277798 or http://dx.doi.org/10.2139/ssrn.3277798

Wei Li

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-0973 (Phone)

Tong Yao

University of Iowa - Henry B. Tippie College of Business ( email )

Acquisitions
5020 Main Library
Iowa City, IA 52242-1000
United States

Jie Ying (Contact Author)

Southern Illinois University at Edwardsville - Department of Economics & Finance ( email )

Edwardsville, IL 62026
United States

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