Optimal Portfolio Allocation for Corporate Pension Funds

David Miles and David McCarthy

No 6394, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We model the asset allocation decision of a defined benefit pension fund using a stochastic dynamic programming approach. Our model recognizes the fact that asset allocation decisions are made by trustees who are mandated to act in the best interests of beneficiaries - not by sponsoring employers - and that trustees 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 - which may cover a portion of deficits in the event of a sponsor default - and a sponsoring employer who may make good any shortfall in assets, and who may reclaim some pension surplus. Our model includes 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). We find that we are able to substantially replicate observed DB pension asset allocations in the UK and conclude that institutional details - in particular asymmetries in payoffs to pension trustees - are crucial in understanding pension asset allocation.

Keywords: Pensions; Portfolio allocation; Longevity (search for similar items in EconPapers)
JEL-codes: G10 G11 G23 G32 J11 (search for similar items in EconPapers)
Date: 2007-07
New Economics Papers: this item is included in nep-cfn and nep-dge
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Optimal Portfolio Allocation for Corporate Pension Funds (2013)
Working Paper: Optimal portfolio allocation for corporate pension funds (2011)
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