Abstract
In this paper, the optimal investment strategy for a defined contribution (DC) pension scheme was modeled with the assumption that the fund is invested partly in riskless assets and partly in risky assets. The market has a constant interest rate, a stochastic volatility that follows the Heston model, the salary is assumed constant over the entire career of the Pension Plan Participant (PPP) and the contribution is a constant proportion of the salary. The CRRA utility function was utilized to obtain a Hamilton-Jacobi-Bellman (HJB) equation. The resulting HJB equation was solved using the Prandtl Asymptotic Matching Method following the works in the literature.
Highlights
The market has a constant interest rate, a stochastic volatility that follows the Heston model, the salary is assumed constant over the entire career of the Pension Plan Participant (PPP) and the contribution is a constant proportion of the salary
The defined contribution (DC) model is a pension model that has predetermined contribution from the Pension Plan Participant (PPP) and the benefit to the PPP depends on the return on investment of the pension assets
The most commonly used utility functions are constant relative risk aversion (CRRA), that is, the power or logarithmic utility function, constant absolute risk aversion (CARA), that is, the exponential utility function and hyperbolic absolute risk aversion (HARA) which is a combo utility function since under different assumptions it can transform to the other types
Summary
The defined contribution (DC) model is a pension model that has predetermined contribution from the Pension Plan Participant (PPP) and the benefit to the PPP depends on the return on investment of the pension assets. The optimal investment strategies derived with Constant Relative Risk Aversion (CRRA) utility function was considered, volatility was assumed to follow the Heston model with constant interest rate, while. The PPP in the DC pension plan seeks to maximize certain utility function based on his attitude to risk. The most commonly used utility functions are constant relative risk aversion (CRRA), that is, the power or logarithmic utility function, constant absolute risk aversion (CARA), that is, the exponential utility function and hyperbolic absolute risk aversion (HARA) which is a combo utility function since under different assumptions it can transform to the other types.
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