How Costly Is Regulatory Short-Termism for Defined-Benefit Pension Funds?
We analyse this question in the context of a formal continuous-time dynamic asset allocation model for an investor facing liability commitments subject to inflation and interest rate risks. In an empirical exercise, we find that the presence of short-term funding ratio constraints indeed involves a positive welfare cost, but that cost is not found to be prohibitive for reasonable parameter values. Recognizing that the presence of minimum funding ratio constraints, whether desirable or not, should affect the optimal allocation policy, we then provide the formal solution to the asset allocation problem in the presence of such constraints. We compare these risk-controlled strategies to unconstrained allocation strategies coupled with additional contributions, and find that the latter involve severe welfare costs in the presence of irreversible contributions and regulatory shorttermism, especially when marginal utility decreases sharply beyond a given threshold. In essence, we show that ri
