Optimal investment of defined contribution pension plan with environmental, social, and governance (ESG) factors in regime-switching jump diffusion models

Abstract

In this article, we address the optimal investment problem for a defined contribution pension plan, taking into account both financial performance and environmental, social, and governance (ESG) factors. We model the surplus of the pension fund using a regime-switching jump diffusion process. To capture the pension managers’ preference toward different kinds of assets, such as green and brown stocks, we utilize the multiple constant relative risk aversion utility. By applying the dynamic programming principle, we derive the optimal investment strategy and the corresponding value function. We also discuss the existence and uniqueness of the optimal solution. Through numerical analysis, we demonstrate that increasing salary and contribution rates, as well as implementing policies related to sustainable development, can effectively encourage pension managers to allocate more of their investments toward green stocks. These findings contribute to a better understanding of the optimal investment decisions in defined contribution pension plans, considering both financial and ESG aspects. In summary, this article can provide valuable insights for both policymakers and practitioners interested in enhancing sustainable investment and aligning pension funds with ESG objectives.