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

A. J G Cairns, David Blake, Kevin Dowd

Research output: Contribution to journalArticle

124 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 languageEnglish
Pages (from-to)843-877
Number of pages35
JournalJournal of Economic Dynamics and Control
Volume30
Issue number5
DOIs
Publication statusPublished - May 2006

Keywords

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

Fingerprint Dive into the research topics of 'Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans'. Together they form a unique fingerprint.

Cite this