Assessing Default Investment Strategies in Defined Contribution Pension Plans

Antolín, Pablo; Payet, Stéphanie; Yermo, Juan

doi:10.1787/fmt-2010-5km7k9tp4bhb

Cited by 20 publications

(17 citation statements)

References 8 publications

Supporting

Mentioning

Contrasting

Unclassified

Order By: Relevance

“…For example, Cairns, Blake, and Dowd (2006) derive optimal path-dependent life-cycle strategies applying stochastic control techniques to maximize expected utility in a defined contribution plan environment. In line with their results, Basu, Byrnes, and Drew (2009) or Antolín, Payet, and Yermo (2010) conclude that path-dependent strategies are superior to deterministic life-cycle funds using simulation techniques and measuring shortfall. In contrast to determining the optimal path-dependent strategy, for example, Maurer, Schlag, and Stamos (2007) and Gomes, Kotlikoff, and Viceira (2008) derive the optimal deterministic life-cycle strategy, that is, the optimal prespecified glide path by maximizing expected utility and conclude that the 'classical' glide path of starting with rather high equity exposure and then reducing the equity exposure over time is optimal.…”

Section: Introductionsupporting

confidence: 63%

Life-cycle funds: Much Ado about Nothing?

Graf

2016

The European Journal of Finance

View full text Add to dashboard Cite

The core idea of life-cycle funds or target-date funds is to decrease the fund's equity exposure and conversely increase its bond exposure towards the fund's target date. Such funds have been gaining significant market share and were recently set as default choice of asset allocation in numerous defined contribution schemes or related old-age provision products in several countries. Hence, an assessment of life-cycle funds' risk-return profiles -that is, the probability distribution of returns -is essential for sustainable financial planning of a large group of investors. This paper studies the risk-return profile of life-cycle funds in particular compared to simple balanced or lifestyle funds that apply a constant equity portion throughout the fund's term instead. In a Black-Scholes model, we derive balanced funds that reproduce the risk-return profile of an arbitrary life-cycle fund for single and regular contributions. We then analyze the accuracy of our results under more complex asset models with stochastic interest rates, stochastic equity volatility and jumps. We further show that frequently used 'rule of thumb approximations' that only take into account the life-cycle fund's average equity portion are not suitable to approximate a life-cycle fund's risk-return profile. Our results on the one hand facilitate sustainable financial planning and on the other hand challenge the very existence of life-cycle funds since appropriately calibrated balanced funds can offer a similar (often dominating) risk-return profile.

show abstract

Section: Introductionsupporting

confidence: 63%

Life-cycle funds: Much Ado about Nothing?

Graf

2016

The European Journal of Finance

View full text Add to dashboard Cite

show abstract

“…The results prove that the life-cycle strategy can be justified even in a framework that includes only financial wealth. Antolin et al (2010) assessed the relative performance of different investment strategies for various pay-out phases. They found that life-cycle strategies that maintain a constant exposure to equities during most of the accumulation period, switching swiftly to bonds in the last decade before retirement, seem to produce better results and are easier to explain.…”

Section: Literature Reviewmentioning

confidence: 99%

Optimal Life-Cycle Investment Strategy in Lithuanian Second Pension Pillar

Medaiskis¹,

Gudaitis²,

Mečkovski³

2018

IJoES

View full text Add to dashboard Cite

The proposition to introduce life-cycle investment strategy as a default option in second pension pillar in Lithuania is currently being intensely discussed as a measure to solve the problems of the irrational behaviour of pension fund participants. The latest analysis has shown that the majority of participants have selected an inappropriate pension fund (investment strategy and investment risk) while evaluating the accumulation period that they have left till the retirement. Moreover, most of them are not active and do not change the pension fund during accumulation period. The life-cycle investment strategy allows participants to switch automatically and gradually from one asset allocation to another as they get closer to retirement. Therefore, such dynamic asset allocation must have a strong analytical foundation. The goal of the study is to evaluate the optimal life-cycle investment strategy in the Lithuanian second pension pillar. In order to achieve this goal, the authors prepared a quantitatively calibrated model that closely follows such works as Cocco et al. (2005), Bagliano et al. (2009) and Blake et al. (2008). The model takes into account the specifics of the Lithuanian market such as contribution rates, the investment performance of pension funds, and participant's labour income process. In this paper, the authors use the optimization problem, where participant's utility is maximized only by the selected investment strategy (without consumption). The results show that from the beginning of accumulation period (the age of 20) till the age of approximately 42 years it is most rational to invest a high proportion of participant's pension assets into equities. Then optimal asset allocation is gradually switching from equities to less risky assets (e.g. government bonds) as the retirement age (65) approaches, where only 19 per cent of assets are invested into equities. The paper consists of three main parts: literature review, the explanation of the model and calibrated parameters that were used to evaluate the optimal life-cycle investment strategy, and main simulation results, including benchmark and sensitivity analysis.

show abstract

“…Other characteristics influencing optimal portfolios include habit formation, liquidity constraints and idiosyncratic labor income shocks (Bodie et al, 2009). Antolin et al (2010) argue that life-cycle strategies that maintain a constant exposure to equities during most of the accumulation period, switching swiftly to bonds in the last decade before retirement, produce better results and are easier to explain. They also observe that the length of the contribution period affects the ranking of the different investment strategies, with life-cycle strategies having a stronger positive impact the shorter the contribution period.…”

Section: Literature Reviewmentioning

confidence: 99%

“…We suggest an accumulating approach to the life-cycle model, in which at the time point when a pension fund member reaches the same (switching) age as above 1 , his previously accumu- 1 Obviously, the correct choice of a pension fund member's age when he switches between the funds with different risk profiles should be performed is a crucially important point in maximizing the member's final savings. Numerous researchers and pension planners have already analyzed and continue to analyze this matter, and there is probably no universal decision in this respect.…”

Section: Research Hypothesismentioning

confidence: 99%