Working Paper: NBER ID: w12970
Authors: Jules H. Van Binsbergen; Michael W. Brandt
Abstract: We study the impact of regulations on the investment decisions of a defined benefits pension plan. We assess the influence of ex ante (preventive) and ex post (punitive) risk constraints on the gains to dynamic, as opposed to myopic, decision making. We find that preventive measures, such as Value-at-Risk constraints, tend to decrease the gains to dynamic investment. In contrast, punitive constraints, such as mandatory additional contributions from the sponsor when the plan becomes underfunded, lead to very large utility gains from solving the dynamic program. We also show that financial reporting rules have real effects on investment behavior. For example, the current requirement to discount liabilities at a rolling average of yields, as opposed to at current yields, induces grossly suboptimal investment decisions.
Keywords: pension plans; investment decisions; regulatory constraints; dynamic investment; asset liability management
JEL Codes: G0; G11; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ex ante preventive constraints (D10) | decrease gains to dynamic investment (G11) |
| ex ante preventive constraints (D10) | limit allowable portfolio weights (G11) |
| limit allowable portfolio weights (G11) | flat peak in value function (D46) |
| ex post punitive constraints (K13) | induce strategic behavior of manager (L21) |
| induce strategic behavior of manager (L21) | large utility gains from dynamic investment strategies (G11) |
| mandatory additional financial contributions (Z23) | first-order risk aversion of manager (D81) |
| first-order risk aversion of manager (D81) | enhances utility gains from dynamic decision-making (D91) |
| financial reporting rules (G38) | suboptimal investment decisions (G11) |
| suboptimal investment decisions (G11) | drives wedge between long-term objectives and short-term risk constraints (L21) |