Herding Behavior and Default in Funded Pension Schemes: The Chilean Case

Abstract

In 1981, Chile replaced the former pay-as-you-go system with a new system based on individual capitalization, private administration of assets, free choice of fund managers, and state oversight of the normal functioning of the companies. The state imposes a minimum guaranteed return for investments and requires that companies hold assets as reserves to cover that guarantee. This requirement generates a herding behavior among companies. We simulate scenarios for pension fund administrators that deviate from the norm in their investment strategies. We find that the reserve requirement is overfunded under the actual conditions.