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Paying for minimum interest rate guarantees: Who should compensate who?

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  • Jensen, Bjarne Astrup

    (Department of Finance, Copenhagen Business School)

  • Sørensen, Carsten

    (Department of Finance, Copenhagen Business School)

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    Abstract

    De ned contribution pension schemes and life insurance contracts often have a minimum interest rate guar- antee as an integrated part of the contract. This guarantee is an embedded put option issued by the institution to the individual, who is forced to hold the option in the portfolio. However, taking the inability to short this saving and other institutional restrictions into account the individual may actually face a restriction on the feasible set of portfolio choices, hence be better o without such guarantees. We measure the e ect of the minimum interest guarantee con- straint through the wealth equivalent and show that guar- antees may induce a signi cant utility loss for relatively risk tolerant investors. We also consider the case with heterogenous investors sha- ring a common portfolio. Investors with di erent risk atti- tudes will experience a loss of utility by being forced to share a common portfolio. However, the relatively risk averse in- vestors are partly compensated by the minimum interest rate guarantee, whereas the relatively risk tolerant investors are su ering a further utility loss.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7176
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    Bibliographic Info

    Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number 2000-1.

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    Length: 31 pages
    Date of creation: 12 Jan 2000
    Date of revision:
    Handle: RePEc:hhs:cbsfin:2000_001

    Contact details of provider:
    Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
    Phone: +45 3815 3815
    Email:
    Web page: http://www.cbs.dk/departments/finance/
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    Related research

    Keywords: Minimum interest rate guarantee; asset allo- cation restrictions; utility loss; wealth equivalent; heteroge- nous investors.;

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    Cited by:
    1. Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2004. "Optimal design of the guarantee for defined contribution funds," ULB Institutional Repository 2013/7602, ULB -- Universite Libre de Bruxelles.
    2. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
    3. Deelstra, Griselda & Grasselli, Martino & Koehl, Pierre-Francois, 2003. "Optimal investment strategies in the presence of a minimum guarantee," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 189-207, August.
    4. Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2003. "Optimal investment strategies in the presence of a minimum guarantee," ULB Institutional Repository 2013/7598, ULB -- Universite Libre de Bruxelles.

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