IDEAS home Printed from https://ideas.repec.org/p/ris/jhisae/0204.html
   My bibliography  Save this paper

Discounting Trillions of Dollars in Pension Obligations: A Better Alternative to Using the Expected Return or Risk-Free Rate

Author

Listed:
  • Woutersen, Tiemen

    (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise)

Abstract

This paper proposes a new discount rate that pension funds can use to discount their future obligations. If the payouts of a pension fund depend on the return of the fund's assets, then neither the risk-free rate nor the expected return is an equitable way to discount future liabilities. Using the newly proposed rate, the expected utilities of a particular stream of payments are the same in each period. This proposed rate is higher than the discount rate that is used by some pension funds but lower than the rate that the U.S. States are required to use.

Suggested Citation

  • Woutersen, Tiemen, 2022. "Discounting Trillions of Dollars in Pension Obligations: A Better Alternative to Using the Expected Return or Risk-Free Rate," Studies in Applied Economics 204, The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.
  • Handle: RePEc:ris:jhisae:0204
    as

    Download full text from publisher

    File URL: https://sites.krieger.jhu.edu/iae/files/2022/03/Discounting-Trillions-of-Dollars-in-Pension-Obligations-A-better-alternative-to-using-the-expected-return-or-risk-free-rate.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Aleksandar Andonov & Rob M.M.J. Bauer & K.J. Martijn Cremers, 2017. "Pension Fund Asset Allocation and Liability Discount Rates," The Review of Financial Studies, Society for Financial Studies, vol. 30(8), pages 2555-2595.
    2. Robert Novy‐Marx & Joshua Rauh, 2011. "Public Pension Promises: How Big Are They and What Are They Worth?," Journal of Finance, American Finance Association, vol. 66(4), pages 1211-1249, August.
    3. O. Emre Ergungor, 2017. "When States Default: Lessons from Law and History," Economic Commentary, Federal Reserve Bank of Cleveland, issue October.
    4. Tomáš Havránek, 2015. "Measuring Intertemporal Substitution: The Importance Of Method Choices And Selective Reporting," Journal of the European Economic Association, European Economic Association, vol. 13(6), pages 1180-1204, December.
    5. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, August.
    6. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    7. Jeffrey R. Brown & David W. Wilcox, 2009. "Discounting State and Local Pension Liabilities," American Economic Review, American Economic Association, vol. 99(2), pages 538-542, May.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Aleksandar Andonov & Joshua D Rauh, 2022. "The Return Expectations of Public Pension Funds," The Review of Financial Studies, Society for Financial Studies, vol. 35(8), pages 3777-3822.
    2. Kenechukwu E. Anadu & James Bohn & Lina Lu & Matthew Pritsker & Andrei Zlate, 2019. "Reach for Yield by U.S. Public Pension Funds," Finance and Economics Discussion Series 2019-048, Board of Governors of the Federal Reserve System (U.S.).
    3. Michael Kisser & John Kiff & Mauricio Soto, 2017. "Do Managers of U.S. Defined Benefit Pension Plan Sponsors Use Regulatory Freedom Strategically?," Journal of Accounting Research, Wiley Blackwell, vol. 55(5), pages 1213-1255, December.
    4. Michaelides, Alexander & Papakyriakou, Panayiotis & Milidonis, Andreas, 2019. "Corporate Pension Plan Funding Levels and Pension Assumptions," CEPR Discussion Papers 13591, C.E.P.R. Discussion Papers.
    5. Benjamin Knox & Jakob Ahm Sørensen, 2024. "Insurers’ Investments and Insurance Prices," Finance and Economics Discussion Series 2024-058, Board of Governors of the Federal Reserve System (U.S.).
    6. Shi, Huai-Long & Zhou, Wei-Xing, 2022. "Factor volatility spillover and its implications on factor premia," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 80(C).
    7. Muhammad Kashif & Thomas Leirvik, 2022. "The MAX Effect in an Oil Exporting Country: The Case of Norway," JRFM, MDPI, vol. 15(4), pages 1-16, March.
    8. Mitchell, O.S. & Piggott, J., 2016. "Workplace-Linked Pensions for an Aging Demographic," Handbook of the Economics of Population Aging, in: Piggott, John & Woodland, Alan (ed.), Handbook of the Economics of Population Aging, edition 1, volume 1, chapter 0, pages 865-904, Elsevier.
    9. Boon, L.N. & Brière, M. & Rigot, S., 2018. "Regulation and pension fund risk-taking," Journal of International Money and Finance, Elsevier, vol. 84(C), pages 23-41.
    10. Robert Novy-Marx & Joshua D. Rauh, 2012. "Linking Benefits to Investment Performance in US Public Pension Systems," NBER Working Papers 18491, National Bureau of Economic Research, Inc.
    11. Lekniūtė, Zina & Beetsma, Roel & Ponds, Eduard, 2019. "U.S. municipal yields and unfunded state pension liabilities," Journal of Empirical Finance, Elsevier, vol. 53(C), pages 15-32.
    12. Andreas G. F. Hoepner & Lisa Schopohl, 2020. "State Pension Funds and Corporate Social Responsibility: Do Beneficiaries’ Political Values Influence Funds’ Investment Decisions?," Journal of Business Ethics, Springer, vol. 165(3), pages 489-516, September.
    13. Chen Lian & Yueran Ma & Carmen Wang, 2019. "Low Interest Rates and Risk-Taking: Evidence from Individual Investment Decisions," The Review of Financial Studies, Society for Financial Studies, vol. 32(6), pages 2107-2148.
    14. de Oliveira Souza, Thiago, 2019. "A critique of momentum anomalies," Discussion Papers on Economics 5/2019, University of Southern Denmark, Department of Economics.
    15. Brown, Jeffrey R. & Pennacchi, George G., 2016. "Discounting pension liabilities: funding versus value," Journal of Pension Economics and Finance, Cambridge University Press, vol. 15(3), pages 254-284, July.
    16. Paul Handro & Bogdan Dima, 2024. "Analyzing Financial Markets Efficiency: Insights from a Bibliometric and Content Review," Journal of Financial Studies, Institute of Financial Studies, vol. 16(9), pages 119-175, May.
    17. Klaus Kaier & Christoph Müller, 2015. "New figures on unfunded public pension entitlements across Europe: concept, results and applications," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 42(4), pages 865-895, November.
    18. Yilie Huang & Yanwei Jia & Xun Yu Zhou, 2024. "Mean--Variance Portfolio Selection by Continuous-Time Reinforcement Learning: Algorithms, Regret Analysis, and Empirical Study," Papers 2412.16175, arXiv.org.
    19. Juhani T. Linnainmaa & Michael R. Roberts, 2016. "The History of the Cross Section of Stock Returns," NBER Working Papers 22894, National Bureau of Economic Research, Inc.
    20. Tania Morris & Jules Comeau, 2020. "Portfolio creation using artificial neural networks and classification probabilities: a Canadian study," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 34(2), pages 133-163, June.

    More about this item

    Keywords

    Discount rate; Pension fund obligations; valuation future obligations;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ris:jhisae:0204. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Steve H. Hanke (email available below). General contact details of provider: https://edirc.repec.org/data/iaejhus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.