The long-run relationship between pension liabilities and asset prices: a cointegration approach

This paper explores the long-term relationship between salaries and asset prices and relates it to asset allocation decisions of defined benefit pension funds. In particular, it discusses whether a 100% bond allocation is indeed the minimum risk position for an ongoing scheme whose benefits accruing to active members rise in line with their wages. The main finding is that, while shorter-run correlation evidence is less consistent, there is indeed a long-run link between the evolution of aggregate salaries and a range of asset classes including equities. This long-run positive linkage is consistent with economic theory. The implications for effective practice in minimum risk asset allocation depend on portfolio rebalancing costs, how much shortand medium-run asset allocations move around the long-term equilibrium, as well as how significant active liabilities are as a proportion of total pension liabilities.