Adequacy of Bond Supply and Cost of Pension Benefits : A Financial Economics Perspective

Despite a large literature studying the link between population aging and financial market returns and some limited studies on the market implications of the pension reform, little has been done to quantify the actuarial impact of an asset allocation shift by pension funds. The latter has become particularly important for plan sponsors who view pension obligations through a financial economics lens. Financial economics points to the importance of matching assets and liabilities in reducing the risk of pension funds. In this context, pension funds may undertake a shift from equities to long-term bonds. Depending on the supply of bonds and other macroeconomic factors, bond prices and yields may or may not be affected, which has implications for the cost of providing pension benefits. The paper attempts to fill the gap in the literature by empirically assessing the adequacy of the supply of bonds, quantifying the price impact, gauging the actuarial cost, and proposing appropriate government policy measures. We find that the supply of long-term bonds is far from sufficient to meet the growing demand by pension funds. The inadequate supply may result in a statistically and economically significant impact on bond yields and an actuarially significant impact on the cost of providing pension benefits. The ramifications should not hold back the shift to bonds by pension funds. Instead, governments should take effective measures to spur bond supply