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Pension Plan Funding and Stock Market Efficiency

By Francesco Franzoni and José M. Marín


The paper discloses a new asset pricing anomaly. The conventional models fail to correctly price firms with defined benefit pension plans. Mispricing arises as a function of the funding level of the pension plan. Firms with a pension surplus have a premium in returns and, more significantly, firms with a shortfall have a discount. We provide evidence in favor of an explanation that is based on investors ’ underreaction to pension plan information. Working under this hypothesis, and exploiting the features of the regulatory environment, we build trading strategies that earn abnormal returns of about 12 % annually, adjusted for the exposures to the market, size, book-to-market, and momentum factors. The findings of the paper have relevance for corporate and public policies, and, possibly, for the debate on momentum in assets prices

Topics: Pension Plans, Defined Benefit, Underreaction, Asset Pricing, Anomalies. ∗Acknowledgements, The authors are greatful to Jonathan Lewellen, Randall Morck, and Robert Stambaugh
Year: 2006
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