Long-term individual financial planning under stochastic dominance constraints

• Published in: Annals of operations research 2020-09, Vol.292 (2), p.973-1000
• Main Authors: Consigli, Giorgio, Moriggia, Vittorio, Vitali, Sebastiano
• Format: Article
• Language: English
• Subjects: Analysis; Asset liability management; Benchmarks; Business and Management; Combinatorics; Decision making; Dominance; Financial planning; Households; Investment; Methods; Operations research; Operations Research/Decision Theory; Personal finance; Policies; Real estate; Retirement; S.I.: Stochastic Optimization:Theory & Applications in Memory of M.Bertocchi; Specifications; Stochastic programming; Theory of Computation
• ISSN: 0254-5330; 1572-9338
• DOI: 10.1007/s10479-019-03253-8

We analyse an optimal goal-based households’ asset-liability management problem characterised by a real estate target and a retirement goal over a long-term planning horizon. The problem is formulated as a multistage stochastic program and we evaluate the impact of second order stochastic dominance (SSD) constraints on different specifications of a family objective function and with respect to three alternative benchmark policies. We define a stochastic linear program in which the SSD constraints are based on a double stochastic matrix, whose effectiveness in determining the decision maker strategies is studied in a case study developed in the second part of the article. We show that depending on the adopted benchmark policy, SSD constraints even if binding far on the planning horizon, may influence the root node investment decision and affect both the investment and the liability optimal policies. Based on an extended computational study we analyse under which conditions and problem formulation, an SSD condition may also imply first order stochastic dominance (FSD). Finally we analyse the relationship between the specification of a minimum shortfall objective with respect to the goals and the introduced SSD constraints at the terminal horizon.