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Long-term individual financial planning under stochastic dominance constraints

Author

Listed:
  • Giorgio Consigli

    (University of Bergamo)

  • Vittorio Moriggia

    (University of Bergamo)

  • Sebastiano Vitali

    (University of Bergamo
    Charles University)

Abstract

We analyse an optimal goal-based households’ asset-liability management problem characterised by a real estate target and a retirement goal over a long-term planning horizon. The problem is formulated as a multistage stochastic program and we evaluate the impact of second order stochastic dominance (SSD) constraints on different specifications of a family objective function and with respect to three alternative benchmark policies. We define a stochastic linear program in which the SSD constraints are based on a double stochastic matrix, whose effectiveness in determining the decision maker strategies is studied in a case study developed in the second part of the article. We show that depending on the adopted benchmark policy, SSD constraints even if binding far on the planning horizon, may influence the root node investment decision and affect both the investment and the liability optimal policies. Based on an extended computational study we analyse under which conditions and problem formulation, an SSD condition may also imply first order stochastic dominance (FSD). Finally we analyse the relationship between the specification of a minimum shortfall objective with respect to the goals and the introduced SSD constraints at the terminal horizon.

Suggested Citation

  • Giorgio Consigli & Vittorio Moriggia & Sebastiano Vitali, 2020. "Long-term individual financial planning under stochastic dominance constraints," Annals of Operations Research, Springer, vol. 292(2), pages 973-1000, September.
    • Handle: RePEc:spr:annopr:v:292:y:2020:i:2:d:10.1007_s10479-019-03253-8
    DOI: 10.1007/s10479-019-03253-8
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    References listed on IDEAS

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    Cited by:

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    2. Mehmet Pinar & Thanasis Stengos & Nikolas Topaloglou, 2022. "Stochastic dominance spanning and augmenting the human development index with institutional quality," Annals of Operations Research, Springer, vol. 315(1), pages 341-369, August.

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    More about this item

    Keywords

    Dynamic stochastic programming; Stochastic dominance; Asset-liability management; Goal-based investing; Life cycle policy; Consumption-investment trade-off;
    All these keywords.

    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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