The Optimal Investment Policy for the Pension Benefit Guaranty Corporation

Abstract

The Pension Benefit Guaranty Corporation (PBGC) registers a preoccupying financial condition since 2002. The existing literature has not yet dealt with the definition of the PBGC’s optimal portfolio policy. This paper builds a theoretical framework for defining its optimal asset allocation in a continuous-time stochastic world. We first recognize the PBGC’s put seller nature and derive optimal portfolio rules inspired by the option hedging literature. We then build a model characteristic of any asset-liability manager, like the PBGC or equivalent bodies in other countries, a defined benefit (DB) pension fund or a defined contribution pension fund subject to a guarantee. The model implementation only requires the availability of the given institution’s balance sheets. We propose an application using the PBGC’s reports in the period 1995-2009. The optimal risky asset proportion, composed of the speculative fund and the cash flow and liabilities hedge terms, appears as low, as the second and - especially - third terms exert a downward pressure on the speculative portfolio component. We eventually compare the asset-liability management principles of the PBGC and a DB pension fund and conclude that, though both institutions have a comparable optimal portfolio structure, their asset allocation differs in the effect of the liabilities hedge fund. Due to a different nature of the PBGC’s and DB pension fund’s liabilities, the corresponding hedge fund decreases (increases) the optimal risky asset proportion in the case of the PBGC (DB pension fund).