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Optimal investment policies for defined benefit pension funds

Published online by Cambridge University Press:  14 February 2007

ARJEN SIEGMANN
ARJEN SIEGMANN
Affiliation:
Vrije Universiteit Amsterdam and Netherlands Central Bank (DNB)
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Abstract

This paper analyzes optimal investment policies for pension funds of a defined benefit (DB) type. The nature of a DB fund induces a natural modeling of preferences being of the mean-downside risk type. With compensation for inflation as an explicit goal of a pension fund, a natural reference point for the risk measure is the future (indexed) value of the liabilities. Results are presented for different levels of inflation uncertainty and its correlation with stock returns. The optimal decision rules show increased risk-taking for funding ratios moving away from the discounted value of the reference point. Furthermore, it is shown that the outcomes are comparable with those using a mean-downside deviation criterion. We provide intuition for the results and compare the outcomes with actual investment policies of six large Dutch pension funds.

Keywords

pension fundsoptimal investmentdefined benefitmean-shortfallloss aversionasset-liability management
Type
Research Article
Information
Journal of Pension Economics & Finance , Volume 6 , Issue 1 , March 2007 , pp. 1 - 20
Copyright
© 2007 Cambridge University Press

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