Robert Novy-Marx

Public Pension Promises: How Big Are They and What Are They Worth?

We calculate the present value of state employee pension liabilities as of June 2009 using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is

An Alternative Three-Factor Model

3.20 trillion. If pensions have higher priority than state debt, the present value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are

Hot and Cold Markets

4.43 trillion. Liabilities are even larger under broader concepts that account for projected salary growth and future service.

Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses

A new factor model consisting of the market factor, an investment factor, and a return-on-equity factor is a good start to understanding the cross-section of expected stock returns. Firms will invest a lot when their profitability is high and the cost of capital is low. As such, controlling for profitability, investment should be negatively correlated with expected returns, and controlling for investment, profitability should be positively correlated with expected returns. The new three-factor model reduces the magnitude of the abnormal returns of a wide range of anomalies-based trading strategies, often to insignificance. The models performance, combined with its economic intuition, suggests that it can be used to obtain expected return estimates in practice.

Financial Valuation of PBGC Insurance with Market‐Implied Default Probabilities

This article considers why housing market conditions, including the ratio of buyers to sellers, expected time-to-sale and transaction prices are sensitive to fundamentals. These high sensitivities result from feedback: market participants optimally respond to shocks in a manner that amplifies a shocks initial impact, which in turn elicits further reinforcing responses. For example, a positive demand shock brings more buyers into a market. This improves the bargaining position of sellers, who then sell more quickly, decreasing the stock of sellers in the market. This further increases the relative number of buyers to sellers, amplifying the initial shock.

The other side of value: The gross profitability premium.

This paper examines the effects of losses in U.S. state pension funds on state borrowing costs. Since public‐employee pension obligations are generally senior to state general obligation bonds, increases in unfunded pension liabilities are a serious concern for municipal bond investors. During the 3 months ending December 2008, losses in state pension funds amounted to between 1% and 6% of annual gross state product, and between 9% and 48% of annual state revenue, depending on the state. Using this cross‐sectional variation, we find that over this period tax‐adjusted municipal bond spreads rose by 10‐20 basis points for each 1% of annual gross state product lost in pension funds by states in the lower half of the credit quality spectrum. A similar result holds for each 10% of annual state revenues lost. The effect is approximately constant over the yield curve, suggesting a constant upward shift in annual risk‐neutral default probabilities. These results are robust to controls for credit ratings and other measures of the state’s fiscal strength. They hold within credit rating categories and are strongest among states with the weakest ratings. We conclude that U.S. state borrowing costs will likely increase if unfunded state liabilities continue to grow, making state debt more expensive to finance.

Is momentum really momentum

In this paper, we use financial valuation techniques to measure the unfunded liabilities associated with the Pension Benefit Guaranty Corporation (PBGC) single-employer pension insurance program. This is an alternative approach to the calculations of expected future PBGC payouts in the PBGC exposure reports. The PBGC insurance is akin to an exchange option, a financial instrument that allows a party to exchange one risky asset for another. Calculating the value of this option for each PBGC-covered plan provides a measure of the fair market price of the PBGC guarantee that is consistent with the finance principles of risk-neutral pricing. That is, the market valuation method reflects the fact that bad outcomes tend to coincide with times when losses are particularly painful. The valuation we perform also reflects the fact that PBGC insurance is triggered only in the case of bankruptcy by drawing on the default probabilities implied by the credit ratings of insured plans. Under the baseline parameters, the PBGC’s insurance of the unfunded liabilities has a financial value of

The Liabilities and Risks of State-Sponsored Pension Plans

358 billion, net of the estimated present value of PBGC premiums.