Optimal Portfolio Strategies with Stochastic Wage Income : The Case of A defined Contribution Pension Plan
We consider a stochastic model for a defined-contribution pension fund in continuous time. In particular, we focus on the portfolio problem of a fund manager who wants to maximize the expected utility of his terminal wealth in a complete financial market. The fund manager must cope with a set of stochastic investment opportunities and with the uncertainty involved by the labor market. After introducing a stochastic interest rate, we assume a market structure characterized by three assets : a riskless asset, a bond and a stock. Moreover, we introduce a stochastic process for salaries, and develop the model according to the stochastic dynamic programming methodology. We show that the optimal portofolio is formed by three components : a speculative component proportional to the market price of risk of the two risky assets through the relative risk aversion index, an hedging component proportional to the diffusion term of the interest rate, and a preference-free hedging component proportional to the volatilities of the salary process. Finally, after specifying a suitable fucntional form for the drift term of the salary process, we find a close form solution to the asset allocation problem.
|Date of creation:||01 Feb 2002|
|Contact details of provider:|| Postal: Place Montesquieu 3, 1348 Louvain-la-Neuve (Belgium)|
Fax: +32 10473945
Web page: https://uclouvain.be/en/research-institutes/immaq/ires
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
- Lucas, Robert E, Jr & Stokey, Nancy L, 1987.
"Money and Interest in a Cash-in-Advance Economy,"
Econometric Society, vol. 55(3), pages 491-513, May.
- Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Robert E. Lucas, Jr. & Nancy L. Stokey, 1985. "Money and Interest in a Cash-in-Advance Economy," NBER Working Papers 1618, National Bureau of Economic Research, Inc.
- Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
- R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
- John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters,in: Theory Of Valuation, chapter 5, pages 129-164 World Scientific Publishing Co. Pte. Ltd..
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
- Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
- Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942, April.
- Menoncin, Francesco, 2002. "Optimal portfolio and background risk: an exact and an approximated solution," Insurance: Mathematics and Economics, Elsevier, vol. 31(2), pages 249-265, October.
- Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
- David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305 World Scientific Publishing Co. Pte. Ltd..
- Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
- Nicole El Karoui & Monique Jeanblanc-Picqué, 1998. "Optimization of consumption with labor income," Finance and Stochastics, Springer, vol. 2(4), pages 409-440.
- Vigna, Elena & Haberman, Steven, 2001. "Optimal investment strategy for defined contribution pension schemes," Insurance: Mathematics and Economics, Elsevier, vol. 28(2), pages 233-262, April.
- Blake, David & Cairns, Andrew J. G. & Dowd, Kevin, 2001. "Pensionmetrics: stochastic pension plan design and value-at-risk during the accumulation phase," Insurance: Mathematics and Economics, Elsevier, vol. 29(2), pages 187-215, October.
- Lioui, Abraham & Poncet, Patrice, 2001. "On optimal portfolio choice under stochastic interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 25(11), pages 1841-1865, November.
- Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2000. "Optimal investment strategies in a CIR framework," ULB Institutional Repository 2013/7594, ULB -- Universite Libre de Bruxelles.
- Boulier, Jean-Francois & Huang, ShaoJuan & Taillard, Gregory, 2001. "Optimal management under stochastic interest rates: the case of a protected defined contribution pension fund," Insurance: Mathematics and Economics, Elsevier, vol. 28(2), pages 173-189, April. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:ctl:louvir:2002005. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anne DAVISTER-LOGIST)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.