Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans

A. J G Cairns; David Blake; Kevin Dowd

doi:10.1016/j.jedc.2005.03.009

Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans

A. J G Cairns, David Blake, Kevin Dowd

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170 Citations (Scopus)

Abstract

We investigate asset-allocation strategies open to members of defined-contribution pension plans with a model that incorporates asset, salary (labour-income) and interest-rate risk. We propose a novel form of terminal utility function, incorporating habit formation, that uses the member's final salary as a numeraire. The paper discusses various properties and characteristics of the optimal asset-allocation strategy both with and without the presence of non-hedgeable salary risk. Finally, we compare the performance of the optimal strategy with some popular alternatives used by pension providers and we conclude that it significantly enhances the welfare of a wide range of potential plan members relative to these other strategies. © 2005 Elsevier B.V. All rights reserved.

Original language	English
Pages (from-to)	843-877
Number of pages	35
Journal	Journal of Economic Dynamics and Control
Volume	30
Issue number	5
DOIs	https://doi.org/10.1016/j.jedc.2005.03.009
Publication status	Published - May 2006

Keywords

Habit formation
HJB equation
Non-hedgeable salary risk
Optimal asset allocation
Stochastic control
Stochastic lifestyling
Utility numeraire

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10.1016/j.jedc.2005.03.009

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title = "Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans",

abstract = "We investigate asset-allocation strategies open to members of defined-contribution pension plans with a model that incorporates asset, salary (labour-income) and interest-rate risk. We propose a novel form of terminal utility function, incorporating habit formation, that uses the member's final salary as a numeraire. The paper discusses various properties and characteristics of the optimal asset-allocation strategy both with and without the presence of non-hedgeable salary risk. Finally, we compare the performance of the optimal strategy with some popular alternatives used by pension providers and we conclude that it significantly enhances the welfare of a wide range of potential plan members relative to these other strategies. {\textcopyright} 2005 Elsevier B.V. All rights reserved.",

keywords = "Habit formation, HJB equation, Non-hedgeable salary risk, Optimal asset allocation, Stochastic control, Stochastic lifestyling, Utility numeraire",

author = "Cairns, {A. J G} and David Blake and Kevin Dowd",

year = "2006",

month = may,

doi = "10.1016/j.jedc.2005.03.009",

language = "English",

volume = "30",

pages = "843--877",

journal = "Journal of Economic Dynamics and Control",

issn = "0165-1889",

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TY - JOUR

T1 - Stochastic lifestyling

T2 - Optimal dynamic asset allocation for defined contribution pension plans

AU - Cairns, A. J G

AU - Blake, David

AU - Dowd, Kevin

PY - 2006/5

Y1 - 2006/5

N2 - We investigate asset-allocation strategies open to members of defined-contribution pension plans with a model that incorporates asset, salary (labour-income) and interest-rate risk. We propose a novel form of terminal utility function, incorporating habit formation, that uses the member's final salary as a numeraire. The paper discusses various properties and characteristics of the optimal asset-allocation strategy both with and without the presence of non-hedgeable salary risk. Finally, we compare the performance of the optimal strategy with some popular alternatives used by pension providers and we conclude that it significantly enhances the welfare of a wide range of potential plan members relative to these other strategies. © 2005 Elsevier B.V. All rights reserved.

AB - We investigate asset-allocation strategies open to members of defined-contribution pension plans with a model that incorporates asset, salary (labour-income) and interest-rate risk. We propose a novel form of terminal utility function, incorporating habit formation, that uses the member's final salary as a numeraire. The paper discusses various properties and characteristics of the optimal asset-allocation strategy both with and without the presence of non-hedgeable salary risk. Finally, we compare the performance of the optimal strategy with some popular alternatives used by pension providers and we conclude that it significantly enhances the welfare of a wide range of potential plan members relative to these other strategies. © 2005 Elsevier B.V. All rights reserved.

KW - Habit formation

KW - HJB equation

KW - Non-hedgeable salary risk

KW - Optimal asset allocation

KW - Stochastic control

KW - Stochastic lifestyling

KW - Utility numeraire

U2 - 10.1016/j.jedc.2005.03.009

DO - 10.1016/j.jedc.2005.03.009

M3 - Article

SN - 0165-1889

VL - 30

SP - 843

EP - 877

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

IS - 5

ER -

Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans

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Keywords

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