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What discount rate should be used to value a cash-flow linked to final salary?

Published online by Cambridge University Press:  01 October 2008

ZAKI KHORASANEE
ZAKI KHORASANEE
Affiliation:
Cass Business School, 106 Bunhill Row, London EC1 8T2 (e-mail: M.Z.Khorasanee@city.ac.uk)
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Abstract

Evidence is presented for a model in which wage growth is positively correlated with equity returns after a time lag of 1–3 years. This model is used to derive the risk premium on an asset which provides a cash flow linked to final salary. Using historic UK data, it is estimated that this risk premium is 0.5% per annum, a much smaller figure than that normally assumed for the equity market. This result has implications for the discount rate that should be used to derive the fair value of final salary pension liabilities.

Type
Articles
Information
Journal of Pension Economics & Finance , Volume 8 , Issue 3 , July 2009 , pp. 351 - 360
Copyright
Copyright © 2008 Cambridge University Press

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