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Portfolio allocation for public pension funds*

Published online by Cambridge University Press:  12 April 2011

GEORGE PENNACCHI  and
MAHDI RASTAD
GEORGE PENNACCHI
Affiliation:
Department of Finance, University of Illinois, 4041 BIF, Box 25, 515 East Gregory Drive, Champaign, IL 61820, USA(e-mail: [email protected])
MAHDI RASTAD
Affiliation:
Department of Economics, University of Illinois, 419 David Kinley Hall, 1407 W. Gregory Drive, Urbana, IL 61801, USA(e-mail: [email protected])
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Abstract

This paper presents a 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 2000–2009 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.

Type
Articles
Information
Journal of Pension Economics & Finance , Volume 10 , Issue 2 , April 2011 , pp. 221 - 245
Copyright
Copyright © Cambridge University Press 2011

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