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Dynamic derivative-based pension investment with stochastic volatility: A behavioral perspective

Author

Listed:
  • Chen, Zheng
  • Li, Zhongfei
  • Zeng, Yan
  • Shen, Yang

Abstract

We study a derivative-based optimal investment strategy for a defined contribution (DC) pension plan under the Heston stochastic volatility model. The investor's preferences are described by an S-shaped utility that combines risk-seeking and loss-averse behaviors, benchmarked to a reference point of retirement savings. By the martingale approach and the inverse Fourier transform method, we obtain a semi-analytical form for the optimal investment strategy. We investigate the distinct roles of various factors, such as preferences, wealth goals, market conditions, in the investor's optimal decision, and clarify the dynamic relationship between these factors and derivatives trading. We also provide comprehensive comparisons between the results derived under prospect theory and expected utility theory. A portfolio decomposition validates that the optimal derivatives trading strategy is influenced by both psychological and risk-averse factors. Numerical illustrations are provided to further elaborate our results.

Suggested Citation

  • Chen, Zheng & Li, Zhongfei & Zeng, Yan & Shen, Yang, 2025. "Dynamic derivative-based pension investment with stochastic volatility: A behavioral perspective," Insurance: Mathematics and Economics, Elsevier, vol. 125(C).
    • Handle: RePEc:eee:insuma:v:125:y:2025:i:c:s0167668725001052
    DOI: 10.1016/j.insmatheco.2025.103158
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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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