Stock Ownership Decisions in Defined Contribution Pension Plans

This paper considers the risk of employee pension accounts when there is a large weighting in own company stock. The effect of reduced diversification and job related risk are considered. Mean-variance and scenario-based stochastic programming models are used for the analysis. The stochastic programming formulation allows for fat tailed return distributions. Company stock is only optimal for employees with very low risk aversion or with very high return expectations for company stock. These conclusions are further strengthened when the possibility of job loss associated with poor company stock performance is included in the model. High observed weightings in company stock in DC pension plans are not explained by rational one-period models. Employees are bearing high levels of risk that is not rewarded, and that can lead to disastrous consequences.