The Optimal Extraction Rate versus the Expected Real Return of a Sovereign Wealth Fund

54 Pages Posted: 10 Sep 2019

See all articles by Knut K. Aase

Knut K. Aase

Norwegian School of Economics (NHH) - Department of Business and Management Science

Petter Bjerksund

Norwegian School of Economics (NHH) - Department of Business and Management Science

Date Written: September 6, 2019

Abstract

With reference to funds established for the benefits of the public at large, a university endowment, or other similar sovereign wealth fund, we demonstrate that the optimal extraction rate from the fund is significantly smaller than the expected real rate of return on the underlying fund. We consider the situation where the influx to the fund has stopped, it is in a steady state, and is invested broadly in the international financial markets. The optimal spending rate secures that the fund is a perpetuity, i.e., it will last 'forever', where the real value of the fund after payments is stationary, while spending according to the expected rate of return will deplete the fund with probability. Optimal portfolio choice and spending are then inconsistent. Our conclusions are contrary to the recommendations of an expert panel to the Norwegian Government Pension Fund Global, as well as at odds with part of the extant literature on the management of endowments of universities.

Keywords: Optimal Extraction Rate, Endowment Funds, Expected Utility, Recursive Utility

JEL Classification: G10, G12, D51, D53, D90, E21

Suggested Citation

Aase, Knut K. and Bjerksund, Petter, The Optimal Extraction Rate versus the Expected Real Return of a Sovereign Wealth Fund (September 6, 2019). NHH Dept. of Business and Management Science Discussion Paper No. 2019/7. Available at SSRN: https://ssrn.com/abstract=3450486 or http://dx.doi.org/10.2139/ssrn.3450486

Knut K. Aase (Contact Author)

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

Petter Bjerksund

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

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