Duration, Systematic Risk, and Employee Valuation of Default-Free Pension Claims

Abstract

Lifetime-contract theory assigns a riskless discount rate for sponsor valuation of pension obligations, but does not address the appropriate discount rate for employee valuation of pension promises. This puts in question the use of a riskless discount rate assumption in many studies which analyze pension claim valuation by employees. This article presents a method for assessing the employees’ discount rate for pension claims. The method involves formulating the beta-duration relationship for these claims and combining this relationship with the capital asset pricing model. Numerical illustrations indicate that even for default-free pension promises, the employees’ discount rate includes a systematic risk premium which may be non-negligible for young employees, but diminishes rapidly as employees grow older. i.e. Journal of Risk and Insurance, Vol. LVII, No. 4 (December 1990), pp. 623-633. (Reprinted with permission of The Journal of Rtik and Insurance.)