DP11052 On the Asset Allocation of a Default Pension Fund

Author(s): Magnus Dahlquist, Ofer Setty, Roine Vestman
Publication Date: January 2016
Keyword(s): age-based investing, default fund, life-cycle model, pension plan design
JEL(s): D91, E21, G11, H55
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=11052

We characterize the optimal default fund in a defined contribution (DC) pension plan. Using detailed data on individuals and their holdings inside and outside the pension system, we find substantial heterogeneity among default investors in terms of labor income, financial wealth, and stock market participation. We build a life-cycle consumption-savings model incorporating a DC pension account and realistic investor heterogeneity. We examine the optimal asset allocation for different realized equity returns and investors and compare it with age-based investing. The optimal asset allocation leads to less inequality in pensions while it moderates the risks through active rebalancing.