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Economic and financial approaches to valuing pension liabilities*

Published online by Cambridge University Press:  29 January 2015

ROBERT NOVY-MARX*
Affiliation:
Simon Graduate School of Business, University of Rochester, 500 Joseph C. Wilson Blvd., Rochester NY 14627, USA (e-mail: robert.novy-marx@simon.rochester.edu)

Abstract

Financial economics holds that payment streams should be valued using discount rates that reflect the cash flows’ risks. In the case of pension liabilities, the appropriate discount rate for a pension fund's liabilities is the expected rate of return on a portfolio that would be held under a liability-driven investment policy. The valuation of defined benefit pension obligations involves choices revolving around deciding: (1) what future benefit payments to recognize today (i.e., which liability concept to use); and (2) from whose point of view to value the liabilities. Moving towards modeling, the distribution of future liabilities using a ‘risk-neutral’ framework, would allow for calculating the present value of the future liabilities more accurately. This would provide policymakers with information more relevant for the decision-making, and it would also permit easier communication of the risks facing the Pension Benefit Guaranty Corporation's PIMS model via a single univariate statistic.

Type
Articles
Copyright
Copyright © Cambridge University Press 2015 

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Footnotes

*

The research reported herein was pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium (RRC); the author also acknowledges support from The Pension Research Council at The Wharton School. All findings and conclusions expressed are solely those of the author and do not represent the views of the SSA or any agency of the federal government, the MRRC, the PRC, or The Wharton School at the University of Pennsylvania.

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