2021/04/18 by Frank Bosserhoff, Bosserhoff, Frank, An Chen +5
Social Sciences · Business, Management and Accounting · Economics, Econometrics and Finance · #Insurance, Mortality, Demography, Risk Management #Financial Literacy, Pension, Retirement Analysis #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.2104.08956
Demographic changes increase the necessity to base the pension system more and more on the second and the third pillar, namely the occupational and private pension plans; this paper deals with Target Date Funds (TDFs), which are a typical investment opportunity for occupational pension planners. TDFs are usually identified with a decreasing fraction of wealth invested in equity (a so-called glide path) as retirement comes closer, i.e., wealth is invested more risky the younger the saver is. We investigate whether this is actually optimal in the presence of non-tradable income risk in a stochastic volatility environment. The retirement planning procedure is formulated as a stochastic optimization problem. We find it is the (random) contributions that induce the optimal path exhibiting a glide path structure, both in the constant and stochastic volatility environment. Moreover, the initial wealth and the initial contribution made to a retirement account strongly influence the fractional amount of wealth to be invested in risky assets. The risk aversion of an individual mainly determines the steepness of the glide path.