Portfolio optimization and intergenerational risk sharing for a collective defined contribution pension plan

Abstract

Abstract In this paper, we use a continuous time stochastic model to study a collective defined contribution pension plan when the interest rate is stochastic, and where the benefit levels are adjusted depending on the performance of the plan, and with risk sharing between different generations. The nominal interest rate is characterized by the Vasicek model, and the pension fund is invested in a financial market consisting of three assets: one risk-free asset, one bond and one risky asset. The participants of the pension plan are the risk bearers, and the plan seeks optimal investment and risk-sharing arrangements for plan sponsors and participants that maximize the expected accumulated discount utility of intermediate benefit adjustments and terminal wealth. Closed-form solutions are derived via the stochastic optimal control approach under constant relative risk aversion utility function. Numerical results show the effects of financial market parameters on the optimal investment strategy and how the optimal benefit changes with respect to different risk aversions and wage increase rates.