How Pension Plan Types Affect Asset Pricing

In previous articles, we discussed that asset prices are a function of who’s buying and selling, the relative sizes of these buyers, and their motivations.

Pension plan types affect pricing in markets, which in turn may have implications in your own trading and allocation decisions.

This topic was covered in the following paper – Asset Pricing and Risk-Sharing Implications of Alternative Pension Plan Systems.

Let’s take a look at the main findings.

Key Takeaways – How Pension Plan Types Affect Asset Pricing

Two main pension types

• Defined Benefit (DB): you get a promised retirement check. A big pension fund invests money and makes payments.
• Defined Contribution (DC): you (and your employer) put money in an account like a 401(k). Your retirement depends on how the investments do.

Main idea: pension funds are massive assetholders, so what they buy and sell can influence prices in financial markets.

Why DB plans matter for markets

• DB pension funds tend to invest more conservatively (more bonds, fewer stocks) than many households would.
• When a big DB fund buys lots of bonds, it pushes bond prices up, which usually means the risk-free interest rate is lower.
• If the pension fund is holding safer asset, someone else has to hold more of the risky assets, so investors demand a bigger reward for stocks: higher equity premium (stocks pay more than safe bonds).
  

New risk channel they emphasize

• DB pensions look “safe” for retirees because benefits are promised.
• But if the pension fund has bad investment returns, the system has to get money somewhere: higher contributions from workers and/or firms.
• That means workers can feel stock market risk indirectly (through contribution hikes), even if they don’t own stocks.

What happens if a country shifts from DB to DC

• Risk-free rate goes up (less giant DB demand for bonds).
• Equity premium goes down (less of that DB-driven “extra” risk/price pressure).
• Retirees get shakier consumption (their income depends more on market outcomes in their own accounts).
• Workers get steadier consumption (they’re no longer absorbing pension-fund shocks through changing contributions).

What Is This Paper About?

This paper studies how different pension systems affect the stock market, interest rates, and how risk is shared in the economy.

There are two main types of pension systems:

Defined Benefit (DB)

You are promised a fixed payment when you retire. A large pension fund invests money for you.

Defined Contribution (DC)

You save money in your own account (like a 401(k)). Your retirement income depends on how your investments perform.

The authors ask:

If a country moves from DB pensions to DC pensions, what happens to the economy and financial markets?

How Do DB Pensions Affect Financial Markets?

DB Pension Funds Are Huge Investors

DB pension funds control a lot of money.

Global pension assets overall (DB + DC) are around $68 trillion as of 2025. The OECD estimates that occupational DB plans are just under one‑third (31.9%) of total pension plan assets at end‑2024.

Applying that share to the latest global totals gives:

• Global pension assets ≈ $68.3 trillion in 2025
• DB share ≈ 32% of total pension assets

That implies global DB pension assets on the order of $21-22 trillion.

Because they’re so big, the way they invest can influence:

• Interest rates
  
• Stock returns
  
• Overall risk in the economy
  

DB Funds Invest More Conservatively

DB pension funds tend to buy more bonds (safer assets) and fewer stocks than many households would otherwise do (i.e., as measured against investment accounts that people control directly).

When a big pension fund buys lots of bonds:

• Bond prices go up
  
• The risk-free interest rate goes down
  

Because the pension fund holds more safe assets, other investors will hold more risky assets (stocks).

So investors demand a bigger reward for holding stocks.

This increases the equity risk premium (the extra return stocks give over safe bonds).

The Hidden Risk in DB Systems

Retirement Looks Safe – But Someone Bears the Risk

In a DB system, retirees get guaranteed payments.

But if the pension fund loses money in the market or the returns are insufficient due to over-conservative allocation, someone has to make up the difference:

• Workers may have to contribute more from their paychecks.
  
• Firms may have to contribute more. This, in turn, reduces profits.
  

This means workers and firms absorb the risk.

Retirees are protected, but others carry the burden.

What Happens If We Switch to DC Pensions?

The paper studies what would happen if DB pensions were replaced by DC pensions.

This has both asset return/interest rate implications and risk angles to it:

Interest Rates and Stock Returns

• The risk-free interest rate goes up (because there is less demand for bonds from big pension funds).
  
• The equity premium goes down (stocks don’t need to offer as large an extra return).
  

Risk Changes for Different Groups

• Retirees face more risk. Their income now depends directly on how their investments perform.
  
• Workers face less risk. They no longer have to deal with sudden increases in pension contributions.
  

So, all else equal, the change in the US from DB (pensions) to DC (e.g., 401(k) and self-managed accounts) has caused risk-free rates to go up due to less bond demand and the equity risk premium to fall due to more demand for stocks.

The Big Idea

DB pensions protect retirees by shifting risk onto workers and firms.

Because DB pension funds are large and invest conservatively, they also affect interest rates and stock returns.

If an economy switches to DC pensions:

• Markets change (higher safe rates, lower extra stock returns).
  
• Risk moves from workers to retirees.
  

So pension systems don’t just affect retirement — they shape the entire financial system.