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

Mei-Ling Tang, Son-Nan Chen, Gene C. Lai and Ting-Pin Wu

Insurance: Mathematics and Economics, 2018, vol. 78, issue C, 87-104

Abstract: 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.

Keywords: Asset allocation; Defined contribution pension plan; Stochastic interest rate; Inflation-indexed bond; Minimum guarantee (search for similar items in EconPapers)
JEL-codes: C61 G11 G23 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:78:y:2018:i:c:p:87-104

DOI: 10.1016/j.insmatheco.2017.11.004

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