Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion

Blake, David and Wright, Douglas and Zhang, Yumeng (2011): Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion.

Abstract

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
• Language: English
• 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 > D91 - Intertemporal Household Choice ; Life Cycle Models and Saving

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