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Pension Funds and Financial Innovation

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  • Zvi Bodie

Abstract

Pension funds have played a critical role in the evolution of the markets for debt and equity securities and their derivatives in the U.S. over the last 15 years. The new securities and markets can largely be explained as responses to the investment demands of pension funds in an environment of increased interest rate volatility and tighter regulation. Defined benefit pension plans offer annuities that have a guaranteed floor specified by the benefit formula. In order to minimize the cost to the sponsor of providing this guarantee, there is a strong incentive to invest an amount equal to the present value of the accumulated benefit obligation in fixed- income securities with a matching duration. The pursuit of duration matching and related immunization strategies by pension funds has contributed to the emergence and rapid growth of markets for zero coupon bonds, GIC's, CMO's, options, and financial futures contracts. Recent changes in accounting rules (FAS 87) and tax law (OBRA) are likely to reinforce the use of immunization strategies.

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  • Zvi Bodie, 1989. "Pension Funds and Financial Innovation," NBER Working Papers 3101, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3101
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    References listed on IDEAS

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    Cited by:

    1. Thomas Crossley & Mario Jametti, 2013. "Pension Benefit Insurance and Pension Plan Portfolio Choice," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 337-341, March.
    2. Velculescu, Delia, 2011. "Private Pension Systems in Emerging Europe: The Uncertain Road Ahead," MPRA Paper 88969, University Library of Munich, Germany, revised 2011.
    3. Vittas, Dimitri, 1998. "Institutional investors and securities markets : which comes first?," Policy Research Working Paper Series 2032, The World Bank.
    4. Vittas, Dimitri & Michelitsch, Roland, 1995. "Pension funds in Central Europe and Russia : their prospects and potential role in corporate governance," Policy Research Working Paper Series 1459, The World Bank.
    5. Vittas, Dimitri, 2000. "Pension reform and capital market development -"feasibility"and"impact"preconditions," Policy Research Working Paper Series 2414, The World Bank.
    6. Warren Tease & Jenny Wilkinson, 1993. "The Provision of Financial Services – Trends, Prospects and Implications," RBA Research Discussion Papers rdp9315, Reserve Bank of Australia.
    7. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.
    8. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.

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