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International Pension Swaps

Zvi Bodie and Robert C. Merton


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.