Asset Pricing and Risk-Sharing Implications of Alternative Pension Plan Systems

Pension systems are often treated as background institutions. Households save, invest, and prepare for retirement. But in reality, pension structures play a central role in financial markets. Large pools of capital are managed collectively. Investment decisions are constrained and risks are redistributed across generations. This paper introduces a new perspective. Pension design is not neutral. Defined benefit plans shape asset prices, risk premia, and economic outcomes. The result is a subtle but powerful mechanism. Pension funds influence both markets and households, and changes in pension systems can reshape the entire financial equilibrium.

Asset Pricing and Risk-Sharing Implications of Alternative Pension Plan Systems

• Nuno Coimbra, Francisco Gomes, Alexander Michaelides, Jialu Shen
• The Journal of Finance, 2026
• A version of this paper can be found here
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Key Academic Insights

Pension funds are major players in asset pricing
The paper shows that incorporating defined benefit pension funds into asset pricing models significantly improves their ability to match real-world data. These funds are large, persistent, and structurally different from households. Their demand for safer assets lowers risk-free rates and increases equity premia.

Institutional constraints matter for market outcomes
Unlike households, pension funds do not optimize freely. They follow rules, face liabilities, and invest more conservatively. This creates imbalances in asset demand that households cannot fully offset. The result is a direct impact on equilibrium prices.

A new risk channel emerges through pension funding
Pension fund returns fluctuate. But promised benefits remain fixed. This gap must be absorbed somewhere. Either workers or firms adjust contributions. This creates an indirect exposure to market risk, even for households that do not invest in equities.

Risk is redistributed across generations
Defined benefit systems provide stable income to retirees. But this stability comes at a cost. Workers and firms absorb shocks through changing contributions. This shifts risk away from retirees and concentrates it in the working population.

Defined benefit systems increase the equity premium
Because pension funds invest conservatively and introduce additional consumption risk for workers, the model generates a higher equity premium and Sharpe ratio. This helps explain long-standing asset pricing puzzles.

Switching to defined contribution changes everything
When the system shifts to defined contribution plans, households must save more individually. The risk-free rate rises. The equity premium falls. And the overall structure of asset demand changes significantly.

Consumption risk moves from workers to retirees
In a defined contribution world, workers face less income volatility. But retirees lose the insurance provided by pension funds. As a result, consumption becomes more volatile in retirement.

Practical Applications for Investment Advisors

Understand the role of pension institutions

Asset prices are not determined by households alone. Large institutional investors, such as pension funds, play a key role. Their constraints and objectives shape market outcomes.

Interpret interest rates and risk premia differently
Low risk-free rates and high equity premia may partly reflect pension fund demand. Ignoring this can lead to misinterpretation of market signals.

Monitor structural shifts in retirement systems
The transition from defined benefit to defined contribution plans is not just a policy change. It has direct implications for expected returns, volatility, and long-term asset allocation.

Incorporate indirect risk exposure
Even investors who do not hold equities may still be exposed to market risk through labor income or pension contributions. Portfolio advice should reflect this broader perspective.

How to Explain This to Clients

“Pension systems do more than provide retirement income. They also influence how financial markets work. In traditional systems, large pension funds invest conservatively and help stabilize income for retirees. But this shifts risk onto workers and firms. As many countries move toward individual retirement accounts, that balance changes. People take on more responsibility and more risk. This affects not just retirement outcomes, but also interest rates and expected returns across the market.”

The Most Important Chart from the Paper

In Figure 2, panel A plots the average wealth accumulation over the life cycle (ages 20 to 100) in the baseline economyand in the DC-only economy, for separately type-A households and type-B households. Panel Bplots the ratio of average wealth accumulation over the life cycle in the DC-only economy relativeto the baseline economy before retirement (ages 20 to 65), separately for type-A households andtype-B households.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index.

Abstract

We show that incorporating defined benefit pension funds in an incomplete markets asset pricing model improves its ability to match the historical equity premium and riskless rate and has important risk-sharing implications. We document the importance of the pension fund’s size and asset demands, and a new risk channel arising from fluctuations in the fund’s returns. We use our calibrated model to study the implications of a shift to an economy with defined contribution plans. The new steady state is characterized by a higher riskless rate and a lower equity premium. Consumption volatility increases for retirees but decreases for workers.