Economic and Financial Approaches to Valuing Pension Liabilities

Simon School Working Paper No. FR 13-28

Pension Research Council Working Paper, PRC WP2013-09

25 Pages Posted: 8 Oct 2013

See all articles by Robert Novy-Marx

Robert Novy-Marx

Simon Business School, University of Rochester; National Bureau of Economic Research (NBER)

Date Written: September 2013

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 (DB) 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 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.

Suggested Citation

Novy-Marx, Robert, Economic and Financial Approaches to Valuing Pension Liabilities (September 2013). Simon School Working Paper No. FR 13-28, Pension Research Council Working Paper, PRC WP2013-09, Available at SSRN: https://ssrn.com/abstract=2337135 or http://dx.doi.org/10.2139/ssrn.2337135

Robert Novy-Marx (Contact Author)

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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