The Effect Of Liquidity Risk On The Financial Perfromance Of Pension Funds In Kenya

Abstract

The fear about disappearing of liquidity from financial markets, when it is most needed, has been becoming more and more pronounced among investors. According to Scholes (2000), one of the reasons for market liquidity failure is the risk-management of financial institutions. Therefore financial institutions should mitigate the risk of evaporating liquidity. Liquidity is a very important asset price determinant, asset prices can be fully derived from investors‟ need for liquidity, and that they avoid financial assets which sell at a premium. Keene and Petersen (2007) observed find that liquidity is an important factor when considering investment decisions they employed the Fama-French time-series regressions approach to examine liquidity as a risk factor affecting stock returns, supports these findings. They conclude that liquidity risk is an important factor even after controlling for the effects of market, size, book-to-market equity and momentum. Pension funds are subject to quite heavy regulation (leveraging, usage of derivatives, short selling, etc.), and therefore enhancing performance through exposure to risk is very limited (Sadka, Dong, & Feng 2011). Pension schemes the world over operate under the basic principles that seek to ensure growth of pension assets to provide an adequate replacement rate for life in retirement without compromising the security of pension investments (Barrow, 2008). Regardless of the particular form of a pension scheme, investment decisions need to be taken, taking into account the retirement benefits that are guaranteed or targeted. In 2 other words, the key task is to ensure that at the end of the day, assets (contributions plus investment returns) are adequate to pay for liabilities at the time they fall due. In the case of a defined benefit (DB) plan, the plan liabilities are defined by the obligations stipulated in the arrangement. In a defined contributory (DC) plan, on the other hand, each individual member of the plan must determine what his targeted benefit level is.