Defined Contribution Pension Plans Research Articles

Optimal asset allocation for DC pension subject to allocation and terminal wealth constraints under a remuneration scheme

. We investigate the optimal investment problem faced by a defined contribution (DC) pension fund manager under simultaneous allocation and expected shortfall (ES) constraints. Under a non concave utility, a Value-at-Risk (VaR) constraint does not lead to the full prevention of moral hazard. As a widely employed risk management tool, whether an ES constraint can provide a more effective protection than a VaR constraint has been a focus point of research. We apply a dual control approach and a concavification technique to solve the ES-constrained optimization problem for a DC pension plan under an incentive scheme and derive the closed-form representations of the optimal wealth and portfolio processes. Furthermore, we compare the effect of an ES constraint on the optimal investment behavior with that under a VaR constraint in the presence of an option-like scheme for the DC pension members. Theoretical and numerical results show that for a relatively low protection level, a joint VaR and an ES constraints induce the same structure of the optimal solution, which implies that for a non concave optimization problem, the ES-based risk management has lost its advantage over the VaR-based risk management. Therefore, it needs to design a more efficient risk measure to improve the risk management for a DC pension plan.

The defined contribution pension plan after retirement under the criterion of a revised loss considering the economic situation

<abstract> <p>Considering the economic situation, we investigate the optimal asset allocation of defined contribution pension funds with random payouts after retirement under a modified criterion of quadratic loss. The HJB equation is derived adhering to the dynamic programming principle, and the time-consistent optimal investment strategy is designed based on the calculus theory. Finally, under two different risk attitudes, namely surplus preference and risk aversion, the impact of key parameters on the optimal investment strategy and the function of minimum loss at the initial moment is compared and analyzed, the economic significance is demonstrated, and the rationality of the model is verified.</p> </abstract>

Back to the funding ratio! Addressing the duration puzzle and retirement income risk of defined contribution pension plans

Effective risk management in pension funds requires the use of appropriate long-term risk and performance indicators. However, Defined Contribution (DC) pension plans currently rely on short-term metrics that don't align with the retirement income goals of beneficiaries. Against this backdrop, we introduce a funding ratio measure for DC plans defined as the plan assets divided by accrued benefits derived from any given (defined) stream of contributions. The funding ratio's denominator is the present value of the total retirement income achievable if all contributions had been invested in fully amortizing fixed-income portfolios called retirement bonds. We also use the retirement bonds to introduce a class of target-income strategies that can effectively reduce income risk as retirement approaches, but also secure minimum funding ratio levels. These simple asset allocation rules strongly dominate the standard target-date fund strategies routinely used by DC plans, in terms of retirement outcomes for beneficiaries.

Target Date Fund Flows Amidst the COVID-19 Pandemic

The popularity of target date funds (TDFs) has recently increased among defined contribution pension plans. Despite their growing importance, how TDF flows and flow-performance relationships have changed in response to the COVID-19 pandemic is yet to be examined, particularly during the March 2020 market turmoil, when bond funds witnessed unprecedented outflows. We find that short-horizon TDFs experienced sizable outflows of over $13.5 billion between February and April 2020, whereas mid- and long-horizon TDFs received inflows over the same period. Given that short-horizon TDFs hold a much larger fraction of their portfolios on fixed-income securities, the outflows from these TDFs, whose fund-of-funds investment structure has been identified as a source of intra-family liquidity provision in previous studies, may have compromised the effectiveness of this liquidity provision mechanism during the COVID-19 market crash. We find that in the aftermath of the pandemic, the flow–performance relationship of short-horizon TDFs becomes markedly more concave, which hints at investors’ greater awareness of the downside risks associated with large outflows following their experience during the COVID-19 turmoil.

Time-consistent strategies between two competitive DC pension plans with the return of premiums clauses and salary risk

. In practice, there is always competition among different pension managers. The competitive pension managers are concerned about their relative performance to make better decisions. In addition, to protect the rights of plan members who die before retirement, most of the defined contribution (DC) pension plans contain return of premiums clauses. In this article, we introduce the return of premiums clauses into two competitive DC pension plans with salary risk. Each pension manager cares about not only his own terminal wealth but also his relative wealth versus his competitor. Both the pension managers are allowed to invest the premiums in a financial market, which consists of one risk-free asset and one risky asset whose price process follows the constant elasticity of variance (CEV) model. We investigate the time-consistent investment strategies of the two pension managers under the mean-variance (MV) criterion. The aim of each pension manager is to maximize the mean and minimize the variance of his relative terminal wealth. The explicit expressions of the time-consistent strategies and the efficient frontiers are obtained via applying the extended stochastic optimal control theory. Some special cases are also discussed in detail. Finally, a numerical simulation demonstrates the results obtained.

Robust time-consistent strategy for the defined contribution pension plan with a minimum guarantee under ambiguity

Robust time-consistent strategy for the defined contribution pension plan with a minimum guarantee under ambiguity

A Genetic Algorithm Approach to Optimal Asset Allocation of Defined Contribution Pension Funds: Evidence From India’s National Pension System

Life cycle asset allocation has recently gained popularity and is the default option in pension funds worldwide. A line of recent studies has refuted its glory and argues that a balanced fund with a fixed allocation throughout the investment horizon may yield better results. The question arises from these studies: What should be the balanced fund’s optimum asset allocation weight? Therefore, the present study uses Genetic Algorithm to obtain the optimum asset allocation weight for India’s defined contribution pension plan subscribers. To validate our result, the study compares the results of a Genetic Algorithm to the outcomes of widely used asset allocation techniques, notably the life cycle and equally weighted strategies. This study holds important policy implications as, given the size of the pension asset and the long investment duration, even a trivial increase in return will substantially impact investment outcomes, affecting the subscribers’ well-being in old age.

Optimal investment for defined-contribution pension plans under money illusion

Optimal investment for defined-contribution pension plans under money illusion

Multi-Period Telser’s Safety-First Portfolio Selection Problem in a Defined Contribution Pension Plan

Multi-Period Telser’s Safety-First Portfolio Selection Problem in a Defined Contribution Pension Plan

Optimal investment strategy for DC pension plan with inflation risk under the hybrid stochastic volatility model

In this paper, we investigate an optimal investment strategy for defined-contribution (DC) pension plan under hybrid stochastic volatility (Heston–Hull–White) model, taking account of the inflation risk and the stochastic salary. The fund wealth is invested in financial market consisting of a risk-free asset, an inflation-indexed bond and a stock with hybrid Heston–Hull–White model. The goal of the pension fund manager is to maximize the expected utility of the terminal real wealth. We derive the Hamilton–Jacobi–Bellman (HJB) equation through the dynamic programming principle, under the constant relative risk aversion (CRRA) utility function, the optimal investment strategy is obtained. Finally, a numerical example is presented to characterize the impacts of financial parameters on the optimal investment strategy.

Are Employees Informed? Evidence from Employee Stock Ownership in Defined Contribution Pension Plans

Are Employees Informed? Evidence from Employee Stock Ownership in Defined Contribution Pension Plans

Optimal investment strategy for the DC pension plan based on jump diffusion model and S-shaped utility

In this paper, we study the optimal investment strategy for a defined contribution pension plan under the jump diffusion model and S-shaped utility. We assume that pension plan members can invest their pension fund in the financial market consisting of a risk-free asset and a risk asset whose price process follows a jump diffusion process. The goal of pension plan managers is to maximize the expected utility of the real terminal wealth under the jump diffusion model and S-shaped utility. We apply Lagrange dual method, concavification technique and martingale method to derive the closed-form expressions of the optimal wealth process and the optimal investment strategy. Finally, we also try to use some numerical analysis to explain the impacts of model parameters on the optimal terminal wealth value and trading strategy.

Optimal investment of DC pension plan under a joint VaR-ES constraint

<abstract><p>In this paper, we investigated an optimal investment problem of a defined contribution (DC) pension plan under a joint Value-at-Risk (VaR) and an expected shortfall (ES) constraint. By using a martingale method, we transformed a dynamic optimization problem to a static pointwise optimization problem and derived the closed-form representations of the optimal wealth and portfolio processes in terms of the state price density. Numerical results showed that in comparison to only an ES constraint or a VaR constraint, the joint VaR-ES constraint can not only improve risk management for the bad economic states but also lower the volatility of the optimal terminal wealth.</p></abstract>

Empirical Analysis of Risk Taking, Investment Efficiency and Diversification in Turkish Defined Contribution Pension Plans

This article empirically studies the risk levels of individual pension portfolios, investment efficiency and also the diversification of the pension investors in Türkiye with a novel administrative data with the month-end snapshots in December 2019. To examine the risk taking behavior, investment efficiency and the level of diversification of the Turkish pension investors, we compute beta coefficients, total risk together with idiosyncratic and systematic risk, Sharpe Ratio, the loss from under-diversification of investors’ pension portfolios. The results indicate that a substantial heterogeneity is evident in portfolio risk and the idiosyncratic risk contributes much more. We also find significant evidence on the inefficiency of investment and our results suggest that most of the Turkish pension investors design their portfolios inefficiently. The losses from under-diversification is widespread among Turkish investors as only a quarter of investors achieve risk reward profile better than the risk reward profile of the domestic benchmark equity index BIST 100.

Valuing Losses of Pension Benefits

Valuing Losses of Pension Benefits

Optimal Investment Strategy for DC Pension Plan with Deposit Loan Spread under the CEV Model

This paper is devoted to determining an optimal investment strategy for a defined-contribution (DC) pension plan with deposit loan spread under the constant elasticity of variance (CEV) model. As far as we know, few studies in the literature have taken loans into account when using the CEV model in financial market contexts. The contribution of this paper is to study the impact of deposit loan spread on DC pension investment strategy. By considering a risk-free asset, a risky asset driven by CEV model, and a loan in the financial market, we first set up the dynamic equation and the asset market model, which are instrumental in achieving the expected utility of ultimate wealth at retirement. Second, the corresponding Hamilton–Jacobi–Bellman (HJB) equation is derived by means of the dynamic programming principle. The explicit expression for the optimal investment strategy is obtained using the Legendre transform method. Finally, different parameters are selected to simulate the explicit solution, and the financial interpretation of the optimal investment strategy is provided. We find that the deposit loan spread has a great impact on the investment strategy of DC pension plans.

Optimal Pension Fund Management with Foreign Investment in a Stochastic Environment

To ensure the success of a pension plan under a self-contained defined contribution (DC) retirement plan, the inclusion of foreign assets in a local pension portfolio could be beneficial for risk diversification and the efficient improvement of a fund’s investment performance during its accumulation phase. This study focuses on developing international asset allocation criteria for a DC pension plan; accordingly, we consider risk exposure relative to stochastic interest rates and ex- change rates with minimum guarantees. An arbitrage-free framework, namely, the cross-currency Heath–Jarrow–Morton interest rate model, is introduced in dynamic optimization programming for the DC pension fund. The proposed solution based on the generalized stochastic framework provides tractable and appropriate criteria for the dynamic allocation of a DC pension fund. The constituents of the optimal solution can reflect changes in investment lifecycles and shifts in risk preferences during the accumulation phase of a DC pension plan.

Optimal management of DC pension fund under the relative performance ratio and VaR constraint

This paper investigates the optimal management of defined contribution pension plan under the Omega ratio and Value-at-Risk (VaR) constraint. Interest and inflation risks are considered, and the financial market consists of cash, a zero-coupon bond, an inflation-indexed zero-coupon bond, and a stock. The goal of the pension manager is to maximize the performance ratio of the real terminal wealth under the VaR constraint. An auxiliary process is introduced to transform the original problem into a self-financing problem. We obtain the optimal terminal wealth under different cases by combining the linearization method, the Lagrange dual method, the martingale method, and the concavification method. There are fourteen cases for the convex penalty function, and there are six cases for the concave penalty function. Besides, when the penalty and reward functions are both power functions, the explicit forms of the optimal investment strategies are obtained. Numerical examples are shown to illustrate the impacts of the performance ratio and VaR constraint.

Good Practice Principles in Modelling Defined Contribution Pension Plans

We establish 16 good practice principles for modelling defined contribution pension plans. These principles cover the following issues: model specification and calibration; modelling quantifiable uncertainty; modelling member choices; modelling member characteristics, such as occupation and gender; modelling plan charges; modelling longevity risk; modelling the post-retirement period; integrating the pre- and post-retirement periods; modelling additional sources of income, such as the state pension and equity release; modelling extraneous factors, such as unemployment risk, activity rates, taxes and welfare entitlements; scenario analysis and stress testing; periodic updating of the model and changing assumptions; and overall fitness for purpose.

Action assignments around the automatic rollover in defined contribution pension plan

Action assignments around the automatic rollover in defined contribution pension plan