Dynamic Optimal Portfolio of Pension Funds When Risk Preferences are Heterogeneous Among Pensioners

Abstract

In many developed countries, pension funds are growing its sizes because of dwindling birthrate and aging population. Portfolio management of their reserved funds arouses public attention. Since agents who participate in pension fund, in particular public pension fund, are heterogeneous, it is not easy in general to agree on a particular portfolio strategy. When we take heterogeneity of risk preferences among members into account, portfolio management problems of pension funds are considered as syndicate problems. Objective functions of pension funds do not tend to be constant absolute or relative risk aversion but tend to be decreasing relative risk aversion. The strategic asset allocation strategy (or constant-mix strategy) that is widely used in pension's asset allocation decision is inconsistent with decreasing relative risk aversion utility function. We formulate a security market model and an optimal portfolio problem for pension fund with heterogeneous risk preferences. The optimal portfolio is characterized as a weighted average of each member's optimal portfolio. Using Japanese public pension fund as an example, it is shown that losses of social welfare by using inefficient risk sharing rules and suboptimal portfolio strategies could be significant.