The Role of Inflation-indexed Bond in Optimal Management of Defined Contribution Pension Plan During the Decumulation Phrase

Abstract

Abstract:In this paper we investigate the optimal investment strategy for a defined contribution (DC) pension plan during the decumulation phrase which is risk-averse and pays close attention to inflation risk. The plan aims to maximize the expected constant relative risk aversion (CRRA) utility from the terminal wealth by investing the wealth in a financial market consisting of an inflation-indexed bond, an ordinary zero coupon bond and a risk-free asset. We derive the optimal investment strategy in closed-form using the dynamic programming approach by solving the corresponding Hamilton-Jacobi-Bellman (HJB) equation. Our theoretical and numerical results reveal that under some rational assumptions, an inflation-indexed bond do has significant advantage to hedge inflation risk.