The Role of International Diversification in Public Pension Systems: The Case of Pakistan

Abstract

Pakistan's pension system is in the process of increasing funding in anticipation of providing for a growing elderly population. The pension assets are mainly invested domestically, as only in January 2007 were regulations changed to allow the purchase of international assets. In this paper, we quantify how diversification of the pension funds to include world financial assets could help in improving the sustainability of Pakistan pensions, by simultaneously increasing expected returns and decreasing volatility. These arguments are made using historical data, and the robustness of our findings is demonstrated using a large variety of alternative assumptions about future asset returns, risks, and correlations. We find that international diversification could dramatically help to create sustainability for Pakistan's main public pension system available to private workers.