Size versus allocation in capital market development: evidence from pension funds and insurance companies

EU capital markets stay small as savings sit in deposits, making insurers and pension funds pivotal if portfolios shift into productive assets.

The European Union’s capital markets remain small and fragmented, limiting investment in the real economy. This is not because of a shortage of household savings but rather that those savings are kept in currency and deposits rather than channelled into capital markets. Insurance companies and pension funds (ICPFs) can mobilise savings and help deepen capital markets. This paper examines the sector’s role in EU capital markets, distinguishing between sector size and portfolio allocation. Using disentangled asset allocation data, we analyse how ICPF investment impacts stock- and bond-market capitalisation, other market indicators and bank lending.

Asset allocation is the primary channel linking ICPFs to capital market development. Domestic investment is positively associated with stock- and bond-market capitalisation. For equity markets, the size channel also matters. We find no significant relationship between the sector and market returns, volatility or bank lending.

These findings suggest that expanding the ICPF sector can support EU capital market development, but this would be more effective if accompanied by appropriate investment allocation. In addition to increasing the size of the sector, policy should therefore focus on fostering investment in productive assets, while preserving the obligation to act in the interest of savers.

Source : Bruegel