hurtin' Merton

Doug Henwood dhenwood at
Fri Sep 25 08:52:57 PDT 1998

[From the Harvard Business School web page describing the research of Robert Merton, partner in the busted hedge fund, Long-Term Capital Management. Proper risk control indeed. Would you trust your pension to this man?]



Robert C Merton

Pension Plans of the Future

Pressure on pension plans is mounting due to the aging of the population in a number of countries. At the same time, employers are seeking to reduce the risk and regulatory burdens imposed by defined benefit plans - that is, plans in which future benefits are both guaranteed and tied to future salary. The result has been a shift towards defined contribution plans (e.g., 401(k) plans in the United States). In transferring the investment risk to individuals, this approach increases the likelihood of inadequate retirement income. To deal with this financial problem, researchers in the Global Financial System project, primarily Dwight B. Crane and Robert C. Merton (with Zvi Bodie of Boston University), are engaged in the design of a new pension plan model of a defined contribution plan that retains as many features as possible of traditional defined benefit plans. For example, employers or employees might contribute a percentage of their salaries to a financial intermediary that would guarantee some level of retirement income, thereby reducing the investment and mortality risk to which employees are exposed. An empirical study aimed at determining how well individuals manage their investments in defined contribution plansis also being conducted.

Risk Capital and Capital Allocation

For the principal financial firms, proper risk control is imperative, and capital allocation exerts an impact on a variety of decisions related to: accounting for the profitability of individual businesses; entering or divesting businesses; determining profit-related employee compensation; choosing from among alternative organizational forms; and managing overall risk. Historically a top-down concern, principally of the CFO/treasurer, with the growing importance of off-balance sheet (derivatives) positions, these issues have also fallen squarely into the domain of the "risk manager," a bottom-up perspective. Of central importance is the need for a unifying framework to reconcile the two perspectives that can be applied on a firmwide basis. The determinants of the costs of risk capital and possible approaches for measuring and allocating these costs to the individual businesses that comprise a firm are receiving particular emphasis in the Global Financial System project. Principal researchers in this area are André F. Perold, Kenneth A. Froot, and Robert C. Merton.

------------------------------------------------------------------------ Robert C Merton
| E-mail: rmerton at | Biography | Publications |
| Finance Unit | HBS Directory |

Last updated Thursday, October 2, 1997

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