Abstract: We consider the choices available to a defined contribution (DC) pension plan member at the time of retirement for conversion of his pension fund into a stream of retirement income. In particular, we compare the purchase at retirement age of a conventional life annuity (i.e., a bond-based investment) with distribution programmes involving differing exposures to equities during retirement. The residual fund at the time of the plan member’s death can either be bequested to his estate or revert to the life office in exchange for the payment of survival credits while alive. The most important decision, in terms of cost to the plan member, is the level of equity investment. We also find that the optimal age to annuitise depends on the bequest utility and the investment performance of the fund during retirement.

Abstract: Two salient features of the competitive structure of the U.S. mutual fund industry are the large number of funds and the sizeable dispersion in the fees funds charge investors, even within narrow asset classes. Portfolio financial performance differences alone do not seem able to fully explain these features. We investigate whether non-portfolio fund differentiation and information/search frictions also play a role in creating these observed industry characteristics. We focus on their impact in a case study of the retail S&P 500 index funds sector. We find that fund proliferation and price dispersion also exist in this sector, despite the funds' financial homogeneity. Furthermore, there was a marked shift in sector assets to more expensive (often newly entered) funds throughout our sample period. Our analysis indicates that these observations are consistent with the presence of both non-portfolio differentiation and information/search frictions. Structural estimation of a novel search-over-differentiated-products model reveals that reasonable magnitudes of investor search costs can explain the considerable price dispersion in the sector, and consumers seem to value funds'' observable attributes such as fund age and the number of other funds in the same fund family in largely plausible ways. The results also suggest that the substantial increase in mutual fund market participation observed during our sample, and the corresponding purchase decisions of novice investors, drove the shift in assets toward more expensive funds. We also find evidence consistent with the presence of switching costs, as distinct from search costs. Using structural estimates of demand parameters and search costs, we investigate the possibility that there are too many sector funds from a social welfare standpoint. The results of this exercise indicate that restricting entry would yield nontrivial gains from reduced search costs and productivity gains from scale economies, but these may be counterbalanced by losses from increased market power and reduced product variety.

Abstract: We consider the choices available to a defined contribution (DC) pension plan member at the time of retirement for conversion of his pension fund into a stream of retirement income. In particular, we compare the purchase at retirement age of a conventional life annuity (i.e., a bond-based investment) with distribution programmes involving differing exposures to equities during retirement. The residual fund at the time of the plan member's death can either be bequested to his estate or revert to the life office in exchange for the payment of survival credits while alive. The most important decision, in terms of cost to the plan member, is the level of equity investment. We also find that the optimal age to annuitise depends on the bequest utility and the investment performance of the fund during retirement.

Abstract: This paper develops an asset allocation framework that incorporates prior beliefs about the extent of stock return predictability explained by asset pricing models. We find that when prior beliefs allow even minor deviations from pricing model implications, the resulting asset allocations depart considerably from and substantially outperform allocations dictated by either the underlying models or the sample evidence on return predictability. Under a wide range of beliefs about model pricing abilities, asset allocations based on conditional models outperform their unconditional counterparts that exclude return predictability.

Abstract: How might retirees consider deploying the retirement assets accumulated in a defined contribution pension plan? One possibility would be to purchase an immediate annuity Another approach, called the "phased withdrawal" strategy in the literature, would have the retiree invest his funds and then withdraw some portion of the account annually Using this second tactic, the withdrawal rate might be determined according to a fixed benefit level payable until the retiree dies or the funds run out, or it could be set using a variable formula, where the retiree withdraws funds according to a rule linked to life expectancy Using a range of data consistent with the German experience, we evaluate several alternative designs for phased withdrawal strategies, allowing for endogenous asset allocation patterns, and also allowing the worker to make decisions both about when to retire and when to switch to an annuity We show that one particular phased withdrawal rule is appealing since it offers relatively low expected shortfall risk, good expected payouts for the retiree during his life, and some bequest potential for the heirs We also find that unisex mortality tables if used for annuity pricing can make women's expected shortfalls higher, expected benefits higher, and bequests lower under a phased withdrawal program Finally, we show that delayed annuitization can be appealing since it provides higher expected benefits with lower expected shortfalls, at the cost of somewhat lower anticipated bequests

Abstract: The emergence of ‘alternative’ investment opportunities, the current bear market and the Wall Street analysts' conflict of interest debacle have put pressure on current investment performance measurement methodologies. This paper presents a survey of classic and modern performance measures and assesses them against objective criteria. Depending upon the market, industry or group of assets studied and the preferences of investors, different measures gain favour, and key questions to address when selecting an appropriate performance measure are proposed. The arguments are demonstrated empirically for the global financial services sector, for which strong evidence in support of using Sharpe ratio-based measures is documented. As a comparison, the paper also looks at firms listed on the UK Alternative Investment Market (AIM), for which a divergence of rankings based on alternative measures is illustrated. General implications for risk management and asset allocations across different asset classes are discussed.

Abstract: This paper reassesses, at the light of economic and financial theory, the well-documented recent evolution of the euro area public debt and equity markets. Doing so leads to associating the EMU and the single market with the changes in fundamentals and financial integration with convergence in pricing. For the public debt market, we stress the observation, conform with predictions, that risk free interest rates are now less volatile in the euro area. But also the fact that the establishment of a single public debt market is still not completed. The current fragmentation is costly to Treasuries and taxpayers and understanding its cause is important to evaluate the prospects of currently considered measures of financial integration.

Abstract: This paper addresses the question of whether a govern- ment entity can invest money on behalf of employees or constitu- ents in a manner comparable to the private sector. We focus on the experience of pension funds operated by state and local govern- ments on behalf of their employees. Using data from a sample of public plans, we find some evidence that after controlling for dif- ferences in asset allocation certain types of political interference lead to a sacrifice of returns on plan assets. Combining data from public and private plans, it appears that public plans earned a sig- nificantly lower rate of return than private plans in 1998, the year for which data was available for both types of plans.

Abstract: Motivated by the success of internal habit formation preferences in explaining asset pricing puzzles, we introduce these preferences in a life-cycle model of consumption and portfolio choice with liquidity constraints, undiversifiable labor income risk and stock-market participation costs. In contrast to the initial motivation, we find that the model is not able to simultaneously match two very important stylized facts: A low stock market participation rate, and moderate equity holdings for those households that do invest in stocks. Habit formation increases wealth accumulation because the intertemporal consumption smoothing motive is stronger. As a result, households start participating in the stock market very early in life, and invest their portfolios almost fully in stocks. Therefore, we conclude that, with respect to its ability to match the empirical evidence on asset allocation behavior, the internal habit formation model is dominated by its time-separable utility counterpart.

Abstract: Recent evidence suggests that all asset returns are predictable to some extent with excess returns on real estate relatively easier to forecast. This raises the issue of whether we can successfully exploit this level of predictability using various market timing strategies to realize superior performance over a buy-and-hold strategy. We find that the level of predictability associated with real estate leads to moderate success in market timing, although this is not necessarily so for the other asset classes examined in general. Besides, real estate stocks typically have higher trading profits and higher mean risk-adjusted excess returns when compared to small stocks as well as large stocks and bonds, even though most real estate stocks are small stocks.

Abstract: The shift from defined benefit to defined contribution plans in the United States has drawn new attention to the effect of participants' asset allocation decisions on their financial resources for retirement. This paper develops a stochastic simulation algorithm to evaluate the effect of holding a broadly diversified portfolio of common stocks, or a portfolio of index bonds, on the distribution of 401(k) account balances at retirement. We compare the alternative distributions of retirement wealth both by showing the empirical distribution of potential wealth values, and by computing the expected utility of these outcomes under standard assumptions about the structure of household preferences. Our analysis highlights the critical role of other sources of wealth, such as Social Security, defined benefit pension annuities, and saving outside retirement plans in determining the expected utility cost of holding equities in the retirement account. Our findings also demonstrate the importance of the equity premium in affecting investors' utility from different retirement asset allocations. Viewed from the beginning of a working career, and given the historical pattern of returns on stocks and bonds, a household that does not have extremely high risk aversion would achieve a higher expected utility by holding a portfolio of stocks rather than bonds.

Abstract: We show that a life-cycle model with realistically calibrated uninsurable labor income risk and moderate risk aversion can simultaneously match stock market participation rates and asset allocation decisions conditional on participation. The key ingredients of the model are Epstein-Zin preferences, two risky assets (stocks and long-term bonds), and a fixed entry cost associated with the investment in risky assets. In this context, moderate preference heterogeneity in risk aversion and in the elasticity of intertemporal substitution is sufficient to deliver our results. Moreover, the model rationalizes the asset allocation puzzle of Canner, Mankiw and Weil (1997).

Abstract: This paper examines asset allocation, account balance, and loan activity of a large representative group of 401(k) plan participants as of year-end 2002 using data gathered by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) in their collaborative effort known as the EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. The EBRI/ICI 401(k) database is the most comprehensive source of 401(k) plan participant-level data available to date, containing 15.5 million active 401(k) plan participants in 46,310 plans with $618.6 billion in assets as of year-end 2002.

Abstract: In this article the author examines the constant and variable liquidity direct real estate price indexes developed by Fisher, Gatzlaff, Geltner, and Haurin and uses them in asset allocation exercises. Review of these indexes suggests they provide improved measures of direct real estate performance that do much to remedy problems resulting from the appraisal-induced smoothing of the NCREIF property index. Optimization results based on the period from 1987 to 2001 indicate that significant overweighting of both direct and securitized real estate was appropriate and that direct and securitized real estate were complementary investments. These results and related considerations suggest that real estate should receive at least a neutral weighting in contemporary institutional portfolios.

Abstract: The invention comprises a risk model and data, and is provided on a secure Web-based, interactive platform, whereby a user can build customized risk analyses and reports, covering multiple asset classes and markets. The invention also organizes and categorizes assets along dimensions best reflecting a user's investment process, determines risk assumed, determines sources of risk, allows viewing of a portfolio's risk exposures, identifies and quantifies sources of volatility, provides streamlined risk reporting, and provides a trade scenario utility.

Abstract: The purpose of this note is to look at the rationale behind popular advice on portfolio allocation among cash, bonds, and stocks. We argue that the typical investment advice is not inconsistent with the behavior of risk-averse expected-utility maximizers. We propose an additional solution to the asset allocation puzzle posed by Niko Canner et al. (1997), who argue that popular advice contradicts financial theory because it is inconsistent with the capital asset pricing model (CAPM) mutual-fund separation theorem. The CAPM asserts that investors should hold the same selection of risky assets, while popular advice is that investors should hold a proportion of bonds to stocks that increases with risk aversion. Using mean-variance (MV) analysis and the CAPM, Canner et al. show that recommended portfolios are far from optimal and that losses from the apparent failure of optimization are not substantial. However, they failed to explain the popular advice within an economic model. We offer a rational model based on stochastic dominance to demonstrate that all popular financial advice portfolios belong to the efficient set for all risk-averse investors. Using the historical annual real returns on bonds and stocks in Canner et al., we cannot ascertain that investment advisors indeed offer bad advice. Rather, we maintain that acting as agents for numerous clients, advisors recommend portfolios that are not inefficient for all risk-averse investors. I. Overview

Abstract: This paper is a concise introduction of the weather derivatives market. We present a brief survey of the market, describe the main products, and illustrate their usage in risk management. We also discuss the key issues in modeling and valuation. Finally, taking weather derivatives as an alternative asset class, we demonstrate their potentials in asset allocation and portfolio management.

Abstract: Academics and practitioners alike have developed numerous techniques for benchmarking investment returns to properly adjust seemingly high numbers for excessive levels of risk. The same, however, cannot be said for liquidity, or the lack thereof. This article develops a model for analyzing the ex ante liquidity premium demanded by the holder of an illiquid annuity. The annuity is an insurance product that is akin to a pension savings account with both an accumulation and decumulation phase. We compute the yield (spread) needed to compensate for the utility welfare loss, which is induced by the inability to rebalance and maintain an optimal portfolio when holding an annuity. Our analysis goes beyond the current literature, by focusing on the interaction between time horizon (both deterministic and stochastic), risk aversion, and preexisting portfolio holdings. More specifically, we derive a negative relationship between a greater level of individual risk aversion and the demanded liquidity premium. We also confirm that, ceteris paribus, the required liquidity premium is an increasing function of the holding period restriction, the subjective return from the market, and is quite sensitive to the individual's endowed (preexisting) portfolio.

Abstract: The author looks into the potential application of Statman9s behavioral finance portfolio to help investors and their advisers formulate an appropriate strategic asset allocation. He starts by reviewing a few major behavioral finance findings and moves on to propose a set of four potential fundamental investment objectives, which investors must prioritize and among which they must allocate 100% of their wealth. He then designs sub-portfolios specifically geared to deliver on each of these objectives. The overall strategic asset allocation is then derived from aggregating these sub-portfolios into a single whole. The author concludes with observations on the unintended benefits of such an approach and an admonition that it does not in any way invalidates the fundamental principles underpinning the strategic asset allocation process.

Abstract: A multiperiod portfolio model provides significant advantages over traditional single-period approaches—especially for long-term investors. Such a framework can enhance risk-adjusted performance and help investors evaluate the probability of reaching financial goals by linking asset and liability policies. Multiperiod portfolio models consist of three basic components: a stochastic scenario generator; a policy rule simulator; and an optimization module that identifies non-dominated solutions. Useful applications are in pension planning, insurance risk management, hedge funds, and asset allocation for individual investors.

Abstract: Which investment choice is most important? Is it allocation among broad asset classes, country allocation, choice of sector, or selection of individual securities? Many investors have a false impression of the relative importance of these choices for two reasons. First, investors fail to distinguish between the activities they choose to emphasize and those with the greatest potential to influence investment results. Second, to the extent that investors do measure the potential influence of an investment activity, they often base their choices on contrived portfolios that are unobtainable. Simulations including thousands of realistic portfolios help us determine the natural dispersion of performance arising from different investment activities, which makes it possible to evaluate the hierarchy of investment choice from a normative perspective.

Abstract: Two salient features of the competitive structure of the U.S. mutual fund industry are the large number of funds and the sizeable dispersion in the fees funds charge investors, even within narrow asset classes. Portfolio financial performance differences alone do not seem able to fully explain these features. We investigate whether non-portfolio fund differentiation and information/search frictions also play a role in creating these observed industry characteristics. We focus on their impact in a case study of the retail S&P 500 index funds sector. We find that fund proliferation and price dispersion also exist in this sector, despite the funds' financial homogeneity. Furthermore, there was a marked shift in sector assets to more expensive (often newly entered) funds throughout our sample period. Our analysis indicates that these observations are consistent with the presence of both non-portfolio differentiation and information/search frictions. Structural estimation of a novel search-over-differentiated-products model reveals that reasonable magnitudes of investor search costs can explain the considerable price dispersion in the sector, and consumers seem to value funds'' observable attributes such as fund age and the number of other funds in the same fund family in largely plausible ways. The results also suggest that the substantial increase in mutual fund market participation observed during our sample, and the corresponding purchase decisions of novice investors, drove the shift in assets toward more expensive funds. We also find evidence consistent with the presence of switching costs, as distinct from search costs. Using structural estimates of demand parameters and search costs, we investigate the possibility that there are too many sector funds from a social welfare standpoint. The results of this exercise indicate that restricting entry would yield nontrivial gains from reduced search costs and productivity gains from scale economies, but these may be counterbalanced by losses from increased market power and reduced product variety.

Abstract: There is provided a method for managing an investment portfolio. The method includes determining a feasible change in value of a first asset, and determining an allocation between the first asset and a second asset based on the feasible change in value of the first asset. The second asset appreciates over a holding period, and the allocation yields an expected minimum future value for the investment portfolio.

Abstract: Recent events in several countries have underscored the importance of good governance in private occupational pension plans. The present paper uses contract theory to analyze the interplay of residual claims and control rights in private pensions. The residual claimant is the plan sponsor in a defined benefit (DB) plan and the pool of beneficiaries in a defined contribution (DC) plan. The main control rights we examine relate to decisions on funding, asset allocation, and asset management. Under complete contracting, governance can be shown to be neutral: DC and DB plans di.er only on risk allocation. If instead contracts are incomplete, a DB (DC) plan should: (1) Assign more vigilance responsibility to the sponsor (beneficiaries); (2) Rely less (more) on trustees; (3) Tend to employ trustees that are professional experts (caring insiders); (4) Assign asset allocation rights tothe sponsor (beneficiaries); (5) have strict funding requirements.