Optimal investment decisions with a liability: The case of defined benefit pension plans

Josa-Fombellida, Ricardo; Rincón‐Zapatero, Juan Pablo

doi:10.1016/j.insmatheco.2006.01.005

Cited by 31 publications

(16 citation statements)

References 15 publications

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“…Lower normal contributions will constantly require the triggering of supplementary contributions which boosts contribution rate volatility. In turn, choosing too high a normal contribution rate 24 This is in line with Josa-Fombellida and Rincón-Zapatero (2006), who find that increasing funding deficits trigger higher risk-taking. A case in point is the underfunded US Pension Benefit Guaranty Corporation which recently announced it would move away from a mostly bond portfolio toward a 55% allocation in equities and non-traditional assets.…”

Section: Worst-case Pension Costs and Contribution Rate Riskmentioning

confidence: 61%

Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints

Maurer

Mitchell

Rogalla

2009

Insurance: Mathematics and Economics

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JEL classification: G11 G15 G2 G23 H3 H55 H71 J26 J32 a b s t r a c t Using a Monte Carlo framework, we analyze the risks and rewards of moving from an unfunded defined benefit pension system to a funded plan for German civil servants, allowing for alternative strategic contribution and investment patterns. In the process we integrate a Conditional Value at Risk (CVaR) restriction on overall plan costs into the pension manager's objective of controlling contribution rate volatility. After estimating the contribution rate that would fully fund future benefit promises for current and prospective employees, we identify the optimal contribution and investment strategy that minimizes contribution rate volatility while restricting worst-case plan costs. Finally, we analyze the time path of expected and worst-case contribution rates to assess the chances of reduced contribution rates for current and future generations. Our results show that moving toward a funded public pension system can be beneficial for both civil servants and taxpayers.

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Section: Worst-case Pension Costs and Contribution Rate Riskmentioning

confidence: 61%

Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints

Maurer

Mitchell

Rogalla

2009

Insurance: Mathematics and Economics

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“…The literature on this subject (see e.g. Berkelaar and Kouwenberg 2003;Rudolf and Ziemba 2004;Owadally and Haberman 2004a;Josa-Fombellida and Rincón-Zapatero 2006) employs broad utility and objective functions on measures of fund levels and contributions, and does not focus on tail risk. This indicates that optimal funding solutions may need to be re-assessed in the light of our findings.…”

Section: Other Related Literaturementioning

confidence: 99%

Tail risk in pension funds: an analysis using ARCH models and bilinear processes

Owadally

2013

Rev Quant Finan Acc

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Citation: Owadally, I. (2014). Tail risk in pension funds: An analysis using ARCH models and bilinear processes. Review of Quantitative Finance and Accounting, 43(2), pp. 301-331. doi: 10.1007/s11156-013-0373-9 This is the accepted version of the paper.This version of the publication may differ from the final published version. Abstract Pension funding rules and practice contain implicit smoothing and counter-cyclical mechanisms. We set up a stylized model to investigate whether this may give rise to tail risk, in the form of large but rare losses, when pension liabilities are imperfectly but optimally hedged by pension fund assets. We find that pension losses follow a nonlinear dynamic process, and we derive a complete description of the stochastic properties of this process using Markov chain and bilinear stochastic process theory. The resulting pension dynamics resembles that of a modified ARCH model, which Permanentsuggests that bursts in volatility may occur, and tail risk may be present. Simulations confirm that pension losses exhibit skewness, leptokurtosis and heavy tails, specially when cash flow smoothing is pronounced. Regulators and investors should be aware of the total amount of smoothing in pension funds as this may contribute to extreme losses, which may adversely affect the security of employee benefits as well as the valuation of firms with corporate pension plans.

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“…We call these “benchmark” strategies because this type of strategies is frequently recommended by investment advisors [17–19]. Similar questions have been investigated by many authors [20–29].…”

Section: Introductionmentioning

confidence: 99%

Long-Run Savings and Investment Strategy Optimization

Gerrard

Guillén

Nielsen

et al. 2014

The Scientific World Journal

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We focus on automatic strategies to optimize life cycle savings and investment. Classical optimal savings theory establishes that, given the level of risk aversion, a saver would keep the same relative amount invested in risky assets at any given time. We show that, when optimizing lifecycle investment, performance and risk assessment have to take into account the investor's risk aversion and the maximum amount the investor could lose, simultaneously. When risk aversion and maximum possible loss are considered jointly, an optimal savings strategy is obtained, which follows from constant rather than relative absolute risk aversion. This result is fundamental to prove that if risk aversion and the maximum possible loss are both high, then holding a constant amount invested in the risky asset is optimal for a standard lifetime saving/pension process and outperforms some other simple strategies. Performance comparisons are based on downside risk-adjusted equivalence that is used in our illustration.

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Optimal investment decisions with a liability: The case of defined benefit pension plans

Cited by 31 publications

References 15 publications

Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints

Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints

Tail risk in pension funds: an analysis using ARCH models and bilinear processes

Long-Run Savings and Investment Strategy Optimization

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