Demographic transition, pension schemes’ investment, and the financial market

There have been lots of theoretical and empirical debates about the impact of demographic transition on the financial market. The main economic theory that is often cited to explain the causality is the lifecycle hypothesis. Since this hypothesis suggests that a lifetime saving pattern of individuals will have an inverted U-shape profile, there is a widely concern for the ‘market meltdown scenario’ whereby the stock market might collapse following the retirement of baby-boomers who will begin to dissipate their accumulated wealth. However, the actual dissaving rates of retired households appear to be relatively low. Therefore, no consensus regarding the actual causality of the demographic impact on asset prices has been reached. This thesis attempts to solve this puzzle by arguing that the strong relationship between asset prices and demographic variables observed since the 1960s may primarily result from a shift in the institutional structure of the financial market. The emergence of financial institutions, particularly pension schemes, has changed the way that the financial market operates. Instead of directly holding assets themselves, households have been using financial services provided by these institutions to manage their investments. By using a panel data from the Family Expenditure Survey, lifetime households’ participation rates in occupational pension schemes and personal pension plans are shown to significantly exhibit a strong hump-shape age pattern with a peak at 35-45. Interestingly, this age group has further been proved to have a long-term significant impact on UK equity prices. After analysing DB pension schemes employed by FTSE100 firms, the long-term asset allocation of these investors appears to significantly be influenced by the age structures of their policyholders. Therefore, the insight gleaned from this thesis strongly suggests that the investment behaviour of pension schemes may represent the underlying mechanism explaining the strong correlation between asset prices and demographic patterns