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Optimal Asset Allocation in Asset Liability Management

Jules H. Van Binsbergen 

Stanford University - Graduate School of Business; Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER)

Michael W. Brandt 

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)
September 2006

EFA 2007 Ljubljana Meetings Paper 
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.