Valuation, Optimal Asset Allocation and Retirement Incentives of Pension Plans

We provide a framework in which we link the valuation and asset allocation policies of de-fined benefits plans with the lifetime marginal productivity schedule of the worker and the pension plan formula. In turn, we examine the retirement policies that are implied by the prim-itives of the model and the value of pension obli-gations. Our model provides an explicit valua-tion formula for a stylized defined benefits plan. The optimal asset allocation policies consist of the replicating portfolio of the pension liabili-ties and the growth optimum portfolio indepen-dent of the pension liabilities. We show that the worker will retire when the ratio of pension benefits to current wages reaches a critical value which depends on the parameters of the pen-sion plan and the discount rate. Using numeri-cal techniques we analyze the feedback effect of retirement policies on the valuation of plans and on the asset allocation decisions.