Italian Pension Funds Struggling with Domestic Sovereign Risk

Abstract

The paper investigates the determinants of Italian pension funds’ exposure to the domestic sovereign bonds through a panel analysis, over the time-period 2008-2014, on a sample of 70 funds and 230 investment lines. We investigate the drivers on sovereign home bias along two main explicative arrows: the familiarity theory, and the opportunity set theory. Results indicate that both factors are significant. However, from a quantitative point of view, the main determinant is the presence of restrictions in the investment mandate. The existence of a minimum guaranteed return increases on average by 11 per cent the weight of the Italian sovereign bonds on the European sovereign portfolio, while extending the investment spectrum outside Europe determines a decrease of 4.5 per cent on average. This finding suggests that exposures to the domestic-sovereign risk of Italian pension funds would probably reduce after specific mandate restrictions have loosened. Since sovereign home bias translates into concentration risk, it may weaken the soundness of the private pension pillar in case the Italian T-bonds suffer from a significant price reduction. Regulators should pay close attention to this issue to enhance the stability of the Italian pension fund industry, considering that such a large sovereign home bias could simultaneously undermine the private and public pension payments.