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Discounting Pension Liabilities: Funding versus Value

Jeffrey R. Brown, George G. Pennacchi

NBER Working Paper No. 21276
Issued in June 2015
NBER Program(s):Aging, Asset Pricing, Public Economics

We argue that the appropriate discount rate for pension liabilities depends on the objective. In particular, if the objective is to measure pension under- or over- funding, a default-free discount rate should always be used, even if the liabilities are themselves not default-free. If, instead, the objective is to determine the market value of pension benefits, then it is appropriate that discount rates incorporate default risk. We also discuss the choice of a default-free discount rate. Finally, we show how cost-of-living adjustments (COLAs) that are common in public pensions can be accounted for and valued in this framework.

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Document Object Identifier (DOI): 10.3386/w21276

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