City Research Online

Abstract

Assuming the loss aversion framework of Tversky and Kahneman (1992), stochastic investment and labour income processes, and a path-dependent fund target, we show that the optimal investment strategy for defined contribution pension plan members is a target-driven 'threshold' strategy, whereby the equity allocation is increased if the accumulating fund is below target and is decreased if it is above. However, if the fund is sufficiently above target, the optimal investment strategy switches to 'portfolio insurance'. We show that the risk of failing to attain the target replacement ratio is significantly lower with target-driven strategies than with those associated with the maximisation of expected utility.

Publication Type:	Article
Additional Information:	NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Economic Dynamics and Control. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Dynamics and Control, Volume 37, Issue 1, January 2013, Pages 195–209, http://dx.doi.org/10.1016/j.jedc.2012.08.001
Publisher Keywords:	Defined contribution pension plan, Dynamic programming, Investment strategy, Loss aversion, Portfolio insurance, Target replacement ratio, Threshold strategy
Subjects:	H Social Sciences > HG Finance
Departments:	Bayes Business School > Finance
SWORD Depositor:	Symplectic Administrator

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