Blake, David and Wright, Douglas and Zhang, Yumeng (2011): Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion.
Download (596Kb) | Preview
Assuming loss aversion, stochastic investment and labour income processes, and a path-dependent target fund, we show that the optimal investment strategy for defined contribution pension plan members is a target-driven 'threshold' strategy. With this strategy, the equity allocation is increased if the accumulating fund is below target and decreased if it is above. However, if the fund is sufficiently above target, the optimal investment strategy switches discretely to 'portfolio insurance'. We show that under loss aversion, the risk of failing to attain the target replacement ratio is significantly reduced compared with target-driven strategies derived from maximising expected utility.
|Item Type:||MPRA Paper|
|Original Title:||Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion|
|Keywords:||Defined Contribution Pension Plan; Investment Strategy; Loss Aversion; Target Replacement Ratio; Threshold Strategy, Portfolio Insurance, Dynamic Programming|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
C - Mathematical and Quantitative Methods > C6 - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling > C63 - Computational Techniques; Simulation Modeling
G - Financial Economics > G2 - Financial Institutions and Services > G23 - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
D - Microeconomics > D9 - Intertemporal Choice and Growth > D91 - Intertemporal Consumer Choice; Life Cycle Models and Saving
|Depositing User:||David Blake|
|Date Deposited:||07. Nov 2011 10:30|
|Last Modified:||12. Feb 2013 10:54|
Benartzi, S., and Thaler, R. (1995). ‘Myopic Loss Aversion and the Equity Premium Puzzle’, Quarterly Journal of Economics, 110, 73-92.
Berkelaar, A. B., Kouwenberg, R., and Post, T. (2004). ‘Optimal Portfolio Choice under Loss Aversion’, Review of Economics and Statistics, 86, 973-87.
Blake, D., Cairns, A., and Dowd, K.(2001). ‘PensionMetrics: Stochastic Pension Plan Design and Value at Risk During the Accumulation Phase’, Insurance: Mathematics and Economics, 29, 187-215.
Blake, D., Cairns, A., and Dowd, K. (2007). ‘The Impact of Occupation and Gender on Pensions from Defined Contribution Plans’, Geneva Papers on Risk & Insurance, 32, 458-82.
Blake, D., Khorasanee, Z., Pickles, J., and Tyrrall, D. (2008) An Unreal Number: How Company Pension Accounting Fosters an Illusion of Certainty, Pensions Institute and Institute of Chartered Accountants in England and Wales.
Boulier, J., Huang, S., and Taillard, G. (2001). ‘Optimal Management under Stochastic Interest Rates: The Case of a Protected Defined Contribution Pension Fund’, Insurance: Mathematics and Economics, 28, 173-189.
Cairns, A., Blake, D., and Dowd, K. (2006). ‘Stochastic Lifestyling: Optimal Dynamic Asset Allocation for Defined Contribution Pension Plans’, Journal of Economic Dynamics and Control, 30, 843-877.
Campbell, J., and Viceira, L. (2002). Strategic Asset Allocation: Portfolio Choice for Long-term Investors, Oxford University Press, Oxford.
Fama, Eugene, and Kenneth French (2002). ‘The Equity Premium’, Journal of Finance, 57, 637-659.
Gerrard, R., Haberman, S., and Vigna, E. (2004). ‘Optimal Investment Choices Post-retirement in a Defined Contribution Pension Scheme’, Insurance: Mathematics and Economics, 35, 321-342.
Gneezy, U., and Potters, J. (1997), ‘An Experiment on Risk Taking and Evaluation Periods’, Quarterly Journal of Economics, 112, 632-45.
Gomes, F. (2005). ‘Portfolio Choice and Trading Volume with Loss-Averse Investors’, Journal of Business, 78, 675-706.
Gomes, F., and Michaelides, A. (2005). ‘Optimal Life-Cycle Asset Allocation: Understanding the Empirical Evidence’, Journal of Finance, 60, 869-904.
Haberman, S., and Vigna, E. (2002). ‘Optimal Investment Strategies and Risk Measures in Defined Contribution Pension Schemes’, Insurance: Mathematics and Economics, 31, 35-69.
Kahneman, D., and Tversky, A. (1979). ‘Prospect Theory: An Analysis of Decision under Risk’, Econometrica, 47, 263-91.
Madrian, B., and Shea, D. (2001). ‘The Power of Suggestion: Inertia in 401(k) Participation and Savings Behaviour’, Quarterly Journal of Economics, 116, 1149-1187.
Mehra, R., and Prescott, E. (1985). ‘The Equity Premium: A Puzzle’, Journal of Monetary Economics, 15, 145–161.
Mitchell, O., and Utkus, S. (2004) Pension Design and Structure: New Lessons from Behavioural Finance, Oxford University Press, Oxford.
Rabin, M. and Thaler, R. (2001). ‘Anomalies: Risk Aversion’, Journal of Economic Perspectives, 219-232.
Samuelson, P.A. (1989). ‘A Case at Last for Age-phased Reduction in Equity’, Proceedings of the National Academy of Science, 86, 9048–9051.
Thaler, R., Tversky, A., Kahneman, D., and Schwartz, A. (1997). ‘The Effect of Myopia and Loss Aversion On Risk Taking: An Experimental Test’, Quarterly Journal of Economics, 112, 647-661.
Tversky A., and Kahneman, D. (1992). ‘Advances in Prospect Theory: Cumulative Representation of Uncertainty’, Journal of Risk and Uncertainty, 5, 297-323.
Vigna, E., and Haberman, S. (2001). ‘Optimal Investment Strategy for Defined Contribution Pension Schemes’, Insurance: Mathematics and Economics, 28, 233-262.