DP16635 The Return Expectations of Public Pension Funds

Author(s): Aleksandar Andonov, Joshua Rauh
Publication Date: October 2021
Keyword(s): asset allocation, extrapolation, institutional investors, pension funds, Return Expectations
JEL(s): D83, D84, G02, G11, G23, G28, H75
Programme Areas: Public Economics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16635

The return expectations of public pension funds are positively related to cross-sectional differences in past performance. This positive relation operates through the expected risk premium, rather than the expected risk-free rate or inflation rate. Pension funds act on their beliefs and adjust their portfolio composition accordingly. Persistent investment skills, risk-taking, efforts to reduce costly rebalancing, and fiscal incentives from unfunded liabilities cannot fully explain the reliance of expectations on past performance. The results are consistent with extrapolative expectations, as the dependence on past returns is greater when executives have personally experienced longer performance histories with the fund.