International Diversification and Labor Income Risk

Members of an occupational pension plan face the same industry shocks, since membership is based on employment industry. An occupational pension fund may therefore design portfolio composition so as to hedge members’ labour income shocks at the industry level. This paper quantifies differences in optimal equity portfolios across investors belonging to different industry-country pairs. We compare these industry-based portfolios to the one that would be optimal for an investor endowed with the average home-country labor income. Our analysis uncovers remarkable heterogeneity across industries in the three investing countries considered - US, Canada and Italy. These results point to a clear-cut role of occupational pension funds in hedging labour income risk through international equity diversification.