Valuing and Hedging Defined Benefit Pension Obligations: The Role of Stocks Revisited

This paper revists two basic questions that are critical for understanding and controlling DB pension risk: How should the value of DB pension liabilities be computed; and how should pension assets be allocated? In particular, we reexamine the role of stocks in valuing and hedging pension obligations. Our approach differs from others in the literature in at least two ways. First, it is one of the few that focuses on market value, and does so by using a derivative approach. Second, it is novel in incorporating new evidence on the time-varying correlation between labor earnings growth and asset returns.