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A portfolio choice problem under risk capacity constraint

Author

Listed:
  • Weidong Tian

    (University of North Carolina at Charlotte)

  • Zimu Zhu

    (University of Southern California)

Abstract

This paper studies the asset allocation problem for a retiree facing longevity risk and living standard risk. We introduce a risk capacity constraint to reduce the living standard risk in the retirement period. Whether the retiree focuses on intertemporal consumption or inheritance wealth, we demonstrate a unique number to measure the expected lump sum of the spending post-retirement. The optimal portfolio is nearly neutral to the stock market movement if the portfolio’s value is higher than this critical value; otherwise, the retiree actively invests in the stock market. As a comparison, we consider a dynamic leverage constraint and show that the corresponding optimal portfolio would lose significantly in stressed markets.

Suggested Citation

  • Weidong Tian & Zimu Zhu, 2022. "A portfolio choice problem under risk capacity constraint," Annals of Finance, Springer, vol. 18(3), pages 285-326, September.
    • Handle: RePEc:kap:annfin:v:18:y:2022:i:3:d:10.1007_s10436-021-00404-5
    DOI: 10.1007/s10436-021-00404-5
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    Cited by:

    1. Weidong Tian & Zimu Zhu, 2022. "Smoothness of the Value Function for Optimal Consumption Model with Consumption-Wealth Utility and Borrowing Constraint," Papers 2210.01016, arXiv.org, revised Dec 2023.

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    More about this item

    Keywords

    Risk capacity; Retirement portfolio; Longevity risk; Leverage constraint;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General

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