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

Author

Listed:
  • Jensen, Bjarne Astrup

    (Department of Finance, Copenhagen Business School)

  • Sørensen, Carsten

    (Department of Finance, Copenhagen Business School)

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.

Suggested Citation

  • Jensen, Bjarne Astrup & Sørensen, Carsten, 2000. "Paying for minimum interest rate guarantees: Who should compensate who?," Working Papers 2000-1, Copenhagen Business School, Department of Finance.
  • Handle: RePEc:hhs:cbsfin:2000_001
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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7176
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    References listed on IDEAS

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    Cited by:

    1. repec:wsi:ijtafx:v:06:y:2003:i:03:n:s0219024903001906 is not listed on IDEAS
    2. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
    3. 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.
    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.
    5. 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.

    More about this item

    Keywords

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

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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