Working Paper: NBER ID: w16456
Authors: George Pennacchi; Mahdi Rastad
Abstract: This paper presents a dynamic 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 to 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.
Keywords: public pension funds; portfolio allocation; risk-taking behavior; funding status
JEL Codes: G11; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Past performance (G14) | Current risk-taking behavior (D91) |
| Higher discount rate (E43) | Riskier asset allocations (G11) |
| Governance structure (G38) | Investment behavior (G11) |