Asset allocation under loss aversion and minimum performance constraint in a DC pension plan with inflation risk |
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Affiliation: | 1. Lingnan (University) College, Sun Yat-sen University, Guangzhou 510275, PR China;2. Sun Yat-sen Business School, Sun Yat-sen University, Guangzhou 510275, PR China;3. School of Mathematics, Lanzhou City University, Lanzhou 730070, PR China;1. Centro de Gestión de la Calidad y del Cambio, Universitat Politècnica de València, Spain;2. Cass Business School, City, University of London, United Kingdom;3. Grupo de Sistemas de Optimización Aplicada, Instituto Tecnológico de Informática, Universitat Politècnica de València, Spain;1. Department of Mathematics, University of Kaiserslautern, Erwin-Schrödinger-Straße, 67663 Kaiserslautern, Germany;2. Department IV – Mathematics, University of Trier, Universitätsring 19, 54296 Trier, Germany |
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Abstract: | In this paper we investigate an optimal investment strategy for a defined-contribution (DC) pension plan member who is loss averse, pays close attention to inflation and longevity risks and requires a minimum performance at retirement. The member aims to maximize the expected S-shaped utility from the terminal wealth exceeding the minimum performance by investing her wealth in a financial market consisting of an indexed bond, a stock and a risk-free asset. We derive the optimal investment strategy in closed-form using the martingale approach. Our theoretical and numerical results reveal that the wealth proportion invested in each risky asset has a V-shaped pattern in the reference point level, while it always increases in the rising lifespan; with a positive correlation between salary and inflation risks, the presence of salary decreases the member’s investment in risky assets; the minimum performance helps to hedge the longevity risk by increasing her investment in risky assets. |
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Keywords: | DC pension plan Minimum performance constraint Loss aversion Martingale approach Inflation risk |
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