Asset allocation for a DC pension fund under stochastic interest rates and inflation-protected guarantee

This paper aims to propose referable asset allocation criteria for a defined-contribution (DC) pension plan under stochastic interest rates and the minimum guarantee of inflation protection on annuities. Motivated by the work of Litterman and Scheinkman (1991), which verifies that interest rate risk...

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Bibliographic Details
Published in:Insurance, mathematics & economics mathematics & economics, 2018-01, Vol.78, p.87-104
Main Authors: Tang, Mei-Ling, Chen, Son-Nan, Lai, Gene C., Wu, Ting-Pin
Format: Article
Language:English
Subjects:
Annuities
Asset allocation
Assets
Defined contribution pension plan
Defined contribution plans
Dynamic programming
Ecological risk assessment
Economic models
Inflation rates
Inflation-indexed bond
Interest rate risk
Interest rates
Mathematical models
Minimum guarantee
Pension funds
Pension plans
Stochastic interest rate
Wealth
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Summary:This paper aims to propose referable asset allocation criteria for a defined-contribution (DC) pension plan under stochastic interest rates and the minimum guarantee of inflation protection on annuities. Motivated by the work of Litterman and Scheinkman (1991), which verifies that interest rate risks could be properly modeled with multiple factors, our proposed model extends the Jarrow and Yildirim (JY, 2003) model to a multi-factor framework, and simultaneously incorporates a stock asset to develop what is called the extended JY model in this study. The extended JY model can specify an economic environment with the consideration of risks arising from nominal and real interest rates, the CPI index (inflation rates), and the value of a stock portfolio, which facilitates to complete the closed-form solutions for the stochastic dynamic programming problem of a DC pension plan. The subsequent numerical experiment examines the allocative behaviors in an inflationary economy. In addition, the term effects among interest rates show to have a substantial impact on allocative decisions, and thus can be properly exploited to improve the final wealth of the pension fund.
ISSN:0167-6687
1873-5959
DOI:10.1016/j.insmatheco.2017.11.004