Can Pension Funds Hedge Wage Risk?

Human capital is the present value of future wages, which can be a large component of the total wealth of active workers. This raises the question of whether labour income risk can be hedged by how the retirement savings of workers are invested. The answer is that it cannot be hedged if correlations between labour income and financial return fluctuations are zero, or close to it. Previous research suggests this is generally the case at the total economy level, when domestic investments are used. This article presents the results of a study addressing the above question at the industry level, using a menu of foreign investment indexes. Specifically, we examine the situations of American and Canadian workers in seven different industries whose pension funds can invest in the equity markets of ten countries, including their own. We find significant positive and negative correlations between wage and return fluctuations, which point to opportunities to hedge labour income risk at the individual industry level through the investment of industry pension funds