Stochastic control of annuity contracts under model misspecification

Abstract

This article analyzes dynamic asset allocation for a defined-contribution pension fund whose benefits are paid in the form of annuities when a pension fund manager takes model misspecification into consideration. In this paper, model misspecification is determined from the level of ambiguity in asset returns, which follows Uppal and Wang’s (2003) framework. Optimal pre-retirement and post-retirement strategies under model misspecification will be used to illustrate the implications of asset and liability management constraint. We conclude that lower levels of ambiguity strengthen the “lifestyle strategy” effect based on our numecal applications. Numerical results demonstrate that when the overall level of ambiguity for an asset return disappears, our model will reduce to the model of Devolder et al., (2003).