Hostname: page-component-78c5997874-j824f Total loading time: 0 Render date: 2024-11-10T11:08:26.041Z Has data issue: false hasContentIssue false
  • English
  • Français

Portfolio allocation for public pension funds*

Published online by Cambridge University Press:  12 April 2011

GEORGE PENNACCHI  and
MAHDI RASTAD
GEORGE PENNACCHI
Affiliation:
Department of Finance, University of Illinois, 4041 BIF, Box 25, 515 East Gregory Drive, Champaign, IL 61820, USA(e-mail: gpennacc@illinois.edu)
MAHDI RASTAD
Affiliation:
Department of Economics, University of Illinois, 419 David Kinley Hall, 1407 W. Gregory Drive, Urbana, IL 61801, USA(e-mail: rastad@illinois.edu)
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper presents a model of a public pension fund's choice of portfolio risk. Optimal portfolio allocations are derived when pension fund management maximize the utility of wealth of a representative taxpayer or when pension fund management maximize their own utility of compensation. The model's implications are examined using annual data on the portfolio allocations and plan characteristics of 125 state pension funds over the 2000–2009 period. Consistent with agency behavior by public pension fund management, we find evidence that funds chose greater overall asset – liability portfolio risk following periods of relatively poor investment performance. In addition, pension plans that select a relatively high rate with which to discount their liabilities tend to choose riskier portfolios. Moreover, consistent with a desire to gamble for higher benefits, pension plans take more risk when they have greater representation by plan participants on their Boards of Trustees.

Type
Articles
Information
Journal of Pension Economics & Finance , Volume 10 , Issue 2 , April 2011 , pp. 221 - 245
Copyright
Copyright © Cambridge University Press 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Adams, J. and Smith, D. (2009) Mind the gap: using derivatives overlays to hedge pension duration. Financial Analysts Journal, 65(4): 60–67.CrossRefGoogle Scholar
Bader, L. and Gold, J. (2007) The case against stock in public pension funds. Financial Analysts Journal, 63(1): 55–62.CrossRefGoogle Scholar
Barro, R. (1974) Are government bonds net wealth? Journal of Political Economy, 82: 1095–1117.CrossRefGoogle Scholar
Benzoni, L., Collin-Dufresne, P. and Goldstein, R. (2007) Portfolio choice over the life-cycle when the stock and labor markets are cointegrated. Journal of Finance, 62: 2123–2167.CrossRefGoogle Scholar
Black, F. (1989) Should you use stocks to hedge your pension liability? Financial Analysts Journal, 45(1) (January/February): 10–12.Google Scholar
Bodie, Z. (1990) The ABO, the PBO and pension investment policy. Financial Analysts Journal, 46(1) (September–October): 27–34.CrossRefGoogle Scholar
Brinson, G., Hood, L. R. and Beebower, G. (1986) Determinants of portfolio performance. Financial Analysts Journal, 42(4): 39–44.CrossRefGoogle Scholar
Brinson, G., Singer, B. and Beebower, G. (1991) Determinants of portfolio performance II: an update. Financial Analysts Journal, 47(3): 40–48.CrossRefGoogle Scholar
Brown, J. and Wilcox, D. (2009) Discounting state and local pension liabilities. American Economic Review: Papers and Proceedings, 99(2): 538–542.CrossRefGoogle Scholar
Bulow, J. (1982) What are corporate pension liabilities? Quarterly Journal of Economics, 97: 435–452.CrossRefGoogle Scholar
Campbell, J. (2006) Household finance. Journal of Finance, 61: 1553–1604.CrossRefGoogle Scholar
Cardinale, M. (2003) Cointegration and the Relationship Between Pension Liabilities and Asset Prices. Watson Wyatt Technical Paper No. 2003-TR-06, Washington, DC: Watson Wyatt Ltd.Google Scholar
Chen, H. and Pennacchi, G. (2009) Does prior performance affect a mutual fund's choice of risk? Theory and further empirical evidence. Journal of Financial and Quantitative Analysis, 44: 745–775.CrossRefGoogle Scholar
Elmendorf, D. and Mankiw, N. G. (1999) Government debt. In Taylor, John and Woodford, Michael (eds), Handbook of Macroeconomics, Volume 1, Issue no. 1. North-Holland, Amsterdam, pp. 1615–1669.CrossRefGoogle Scholar
Geanakoplos, J. and Zeldes, S. (2010) Market valuation of accrued social security benefits. In Lucas, D. (ed.), Measuring and Managing Federal Financial Risk. Chicago, IL: University of Chicago Press, pp. 213–233..CrossRefGoogle Scholar
Gold, J. and Hudson, N. (2003) Creating value in pension plans (or, gentlemen prefer bonds). Journal of Applied Corporate Finance, 15(4): 51–57.CrossRefGoogle Scholar
Gürkaynak, R., Sack, B. and Wright, J. (2007) The U.S. treasury yield curve: 1961 to the present. Journal of Monetary Economics, 54: 2291–2304.CrossRefGoogle Scholar
Gürkaynak, R., Sack, B. and Wright, J. (2008) The TIPS yield curve and inflation compensation. Finance and Economics Discussion Series Working Paper No. 2008–05, Federal Reserve Board.CrossRefGoogle Scholar
Jermann, U. (1999) Social security and institutions for intergenerational, intragenerational, and international risk sharing: a comment. Carnegie-Rochester Series on Public Policy, 50: 205–212.CrossRefGoogle Scholar
Lucas, D. and Zeldes, S. (2006) Valuing and hedging defined benefit pension obligations – the role of stocks revisited. Working Paper Northwestern and Columbia Universities.Google Scholar
Lucas, D. and Zeldes, S. (2009) How should public pension plans invest? American Economic Review, 99(2): 527–532.CrossRefGoogle Scholar
Lustig, H. and Van Nieuwerburgh, S. (2008) The returns on human capital: good news on wall street is bad news on main street. Review of Financial Studies, 21(5): 2097–2137.CrossRefGoogle Scholar
Mankiw, G. and Zeldes, S. (1991) The consumption of stockholders and nonstockholders. Journal of Financial Economics, 29: 97–112.CrossRefGoogle Scholar
McDonald, R. (1983) Government debt and private leverage: an extension of the Miller theorem. Journal of Public Economics, 22: 303–325.CrossRefGoogle Scholar
Mercer LLC (2010) Mercer Pension Discount Yield Curve and Index Rates, available at http://www.mercer.com/pensiondiscountGoogle Scholar
Merton, R. (1980) On estimating the expected return on the market: an exploratory investigation. Journal of Financial Economics, 8(4): 323–361.CrossRefGoogle Scholar
Modigliani, F. and Miller, M. (1958) The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3): 261–297.Google Scholar
Munnell, A. and Soto, M. (2007) State and Local Pensions are Different from Private Plans. Boston College Center for Retirement Research Brief SLP 1.Google Scholar
Park, Y. (2009) Public pension plan asset allocations. Employee Benefit Research Institute Notes, 30(4): 1–11.Google Scholar
Peng, J. (2009) State and Local Pension Fund Management. Boca Raton, FL: CRC Press.Google Scholar
Pennacchi, G. and Rastad, M. (2010) Portfolio allocation for public pension funds. National Bureau of Economic Research Working Paper No. 16456.CrossRefGoogle Scholar
Peskin, M. (2001) Asset/liability management in the public sector. In Mitchell, Olivia and Hustead, Edwin (eds), Pensions in the Public Sector. Philadelphia, PA: University of Pennsylvania Press, pp. 195–217.Google Scholar
Novy-Marx, R. and Rauh, J. (2009) The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives, 23(4): 191–210.CrossRefGoogle Scholar
Ricardo, D. (1820) Essay on the Funding System. Published posthumously in Encyclopaedia Britannica: Supplement (1824).Google Scholar
Ruthen, S. (2005) Defined benefit pension plans' interest rate exposure at record high. PIMCO Publication, (February): 1–6.Google Scholar
Ryan, R. and Fabozzi, F. (2002) Rethinking pension liabilities and asset allocation. Journal of Portfolio Management, 28(Summer): 1–9.CrossRefGoogle Scholar