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

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

Abstract

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.

Suggested Citation

  • Blake, David & Wright, Douglas & Zhang, Yumeng, 2011. "Target-driven investing: Optimal investment strategies in defined contribution pension plans under loss aversion," MPRA Paper 34278, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:34278
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    References listed on IDEAS

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    Cited by:

    1. Butt, Adam & Khemka, Gaurav, 2015. "The effect of objective formulation on retirement decision making," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 385-395.
    2. Yao, Haixiang & Yang, Zhou & Chen, Ping, 2013. "Markowitz’s mean–variance defined contribution pension fund management under inflation: A continuous-time model," Insurance: Mathematics and Economics, Elsevier, vol. 53(3), pages 851-863.
    3. Wu, Huiling & Zhang, Ling & Chen, Hua, 2015. "Nash equilibrium strategies for a defined contribution pension management," Insurance: Mathematics and Economics, Elsevier, vol. 62(C), pages 202-214.
    4. repec:eee:insuma:v:79:y:2018:i:c:p:210-224 is not listed on IDEAS
    5. repec:spr:annopr:v:260:y:2018:i:1:d:10.1007_s10479-016-2387-x is not listed on IDEAS
    6. Di Giacinto, Marina & Federico, Salvatore & Gozzi, Fausto & Vigna, Elena, 2014. "Income drawdown option with minimum guarantee," European Journal of Operational Research, Elsevier, vol. 234(3), pages 610-624.
    7. Yao, Haixiang & Chen, Ping & Li, Xun, 2016. "Multi-period defined contribution pension funds investment management with regime-switching and mortality risk," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 103-113.
    8. Agnieszka Konicz & David Pisinger & Alex Weissensteiner, 2015. "Optimal annuity portfolio under inflation risk," Computational Management Science, Springer, vol. 12(3), pages 461-488, July.
    9. Wu, Huiling & Zeng, Yan, 2015. "Equilibrium investment strategy for defined-contribution pension schemes with generalized mean–variance criterion and mortality risk," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 396-408.
    10. Yao, Haixiang & Lai, Yongzeng & Ma, Qinghua & Jian, Minjie, 2014. "Asset allocation for a DC pension fund with stochastic income and mortality risk: A multi-period mean–variance framework," Insurance: Mathematics and Economics, Elsevier, vol. 54(C), pages 84-92.
    11. Wiafe, Osei K. & Basu, Anup K. & Chen, John, 2017. "The effects of age pension on retirement drawdown choices," Finance Research Letters, Elsevier, vol. 20(C), pages 81-87.
    12. repec:eee:dyncon:v:88:y:2018:i:c:p:70-103 is not listed on IDEAS
    13. repec:eee:insuma:v:75:y:2017:i:c:p:137-150 is not listed on IDEAS
    14. repec:eee:insuma:v:76:y:2017:i:c:p:172-184 is not listed on IDEAS
    15. repec:gam:jrisks:v:5:y:2017:i:4:p:57-:d:117091 is not listed on IDEAS

    More about this item

    Keywords

    Defined Contribution Pension Plan; Investment Strategy; Loss Aversion; Target Replacement Ratio; Threshold Strategy; Portfolio Insurance; Dynamic Programming;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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