Revealing the Black Box of Pension Fund Behavior : An Empirical Analysis of Norwegian Pension Funds in a Reach-for-Yield Environment

Abstract

After the financial crisis in 2008, low-interest rates, increased life expectancy, and falling birth rates have put pension funds under pressure. In response, pension funds have increased their allocation towards risky assets to meet their return guarantees (the basic interest rate). This thesis analyses the determinants of the asset allocation of Norwegian pension funds. Further, we examine how the increased allocation to risky assets has impacted their relative performance and solvency position. We provide evidence that the basic interest rate is an important determinant for the allocation to risky assets. Our results suggest that public and private funds react differently to a change in the basic interest rate. Moreover, our analysis showcase that funds with higher buffer capital tend to utilize their risk capacity by investing more in risky assets. Additionally, our evidence indicates that public funds outperform the benchmark when they reach for yield, compared to private funds. Furthermore, we have examined the solvency position of the funds. Our analysis suggests that the reach for yield has negatively impacted their solvency position, ceteris paribus. However, we find that the building of buffer capital has offset the negative effect of the increased risky allocation. Lastly, our analysis highlights that funds with an inadequate solvency position react to this by reaching for yield.