International pension swaps

Abstract

During the past twenty years, swap contracts have become key financial ‘adapters’ linking diverse national financial systems to the global financial network. Today banks and investment companies around the world use swaps extensively to manage their currency, interest-rate, and equity-market risks and to lower their transaction costs. Yet pension funds, which have grown rapidly over that same 20-year period, hardly use swaps at all. This paper suggests how pension funds could use swaps to achieve the risk-sharing benefits of broad international diversification and hedging while avoiding the ‘flight’ of scarce domestic capital to other countries. The paper also shows how swaps can be used to lower the risks of expropriation and to lower the other transaction costs of investing in other countries.