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

  • Jensen, Bjarne Astrup

    (Department of Finance, Copenhagen Business School)

  • Sørensen, Carsten

    (Department of Finance, Copenhagen Business School)

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    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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    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
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