Pension Funds under Investments Constraints: An Assessment of the Opportunity Cost to the Greek Social Security System

In this paper we study the opportunity loss of the Greek social security system in terms of risk and return, caused by the inflexible investment constraints under which Greek pension funds operated in the period 1958-2000. Using data on pension fund reserves as well as on money and capital market yields, we evaluate retrospectively the risks and returns of a more pro-investment fund reserve management by analyzing an indicative number of investment scenarios in local and international money and capital markets. In order to estimate local currency yields for international investment, we generate for the entire period – covering both a fixed and a partially floating exchange rates regime – a corresponding series of exchange rate variations based on the official rate fluctuations and inflation differentials. Our results suggest that in the 43-year period, there has been a significant opportunity loss in the system both in risk and returns: first, by excluding Greek bank deposits and Greek capital market securities that would have propped returns up at acceptable levels of risk and, second, by not allowing for some degree of international diversification that would have kept overall downside risk down. This opportunity loss could have alleviated, to some extent, the current imbalance of the system, had some of the restrictive investment rules been relaxed.