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Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion

  • Blake, David
  • Wright, Douglas
  • Zhang, Yumeng

Assuming loss aversion, stochastic investment and labour income processes, and a path-dependent target fund, we show that the optimal investment strategy for defined contribution pension plan members is a target-driven 'threshold' strategy. With this strategy, the equity allocation is increased if the accumulating fund is below target and decreased if it is above. However, if the fund is sufficiently above target, the optimal investment strategy switches discretely to 'portfolio insurance'. We show that under loss aversion, the risk of failing to attain the target replacement ratio is significantly reduced compared with target-driven strategies derived from maximising expected utility.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34278.

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Date of creation: Sep 2011
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Handle: RePEc:pra:mprapa:34278
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  23. Steffensen, Mogens, 2011. "Optimal consumption and investment under time-varying relative risk aversion," Journal of Economic Dynamics and Control, Elsevier, vol. 35(5), pages 659-667, May.
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