Optimal Portfolio Strategies with Stochastic Wage Income: The Case of A defined Contribution Pension Plan

Paolo Battocchio
Additional contact information
Paolo Battocchio: UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)

No 2002005, LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES)

Abstract: We consider a stochastic model for a defined-contribution pension fund in continuous time. In particular, we focus on the portfolio problem of a fund manager who wants to maximize the expected utility of his terminal wealth in a complete financial market. The fund manager must cope with a set of stochastic investment opportunities and with the uncertainty involved by the labor market. After introducing a stochastic interest rate, we assume a market structure characterized by three assets : a riskless asset, a bond and a stock. Moreover, we introduce a stochastic process for salaries, and develop the model according to the stochastic dynamic programming methodology. We show that the optimal portofolio is formed by three components : a speculative component proportional to the market price of risk of the two risky assets through the relative risk aversion index, an hedging component proportional to the diffusion term of the interest rate, and a preference-free hedging component proportional to the volatilities of the salary process. Finally, after specifying a suitable fucntional form for the drift term of the salary process, we find a close form solution to the asset allocation problem.

Keywords: defined-contribution pension plan; salary risk; stochastic optimal control; Hamilton-Jacobi-Bellman equation (search for similar items in EconPapers)
JEL-codes: C61 G11 G23 (search for similar items in EconPapers)
Pages: 19
Date: 2002-02-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://sites.uclouvain.be/econ/DP/IRES/2002-5.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ctl:louvir:2002005

Access Statistics for this paper

More papers in LIDAM Discussion Papers IRES from Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) Place Montesquieu 3, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Bibliographic data for series maintained by Virginie LEBLANC ().