Optimal Portfolio Strategies with Stochastic Wage Income and Inflation: The Case of a Defined Contribution Pension Plan

Paolo Battocchio () and Francesco Menoncin ()
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Paolo Battocchio: Università degli Studi di Trieste, Dipartimento di Matematica Applicata

No 19, CeRP Working Papers from Center for Research on Pensions and Welfare Policies, Turin (Italy)

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 with stochastic interest rate. The fund manager must cope with a set of stochastic investment opportunities and two background risks: the salary risk and the inflation risk. We use the stochastic dynamic programming approach. We show that the presence of the inflation risk can solve some problems linked to the use of the stochastic dynamic programming technique, and namely to the stochastic partial differential equation deriving from it. We find a closed form solution to the asset allocation problem, without specifying any functional form for the coe±cients of the diffusion processes involved in the problem. Finally, the derivation of a closed form solution allows us to analyse in detail the behaviour of the optimal portfolio with respect to salary and inflation.

Keywords: defined-contribution pension plan; salary risk; inflation 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: 28 pages
Date: 2002-03
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Citations: View citations in EconPapers (4)

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