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- Title
Dynamic Liability-Driven Investment under Sponsor's Loss Aversion.
- Authors
Lee, Dong-Hwa; Sung, Joo-Ho
- Abstract
This paper investigates a dynamic liability-driven investment policy for defined-benefit (DB) plans by incorporating the loss aversion of a sponsor, who is assumed to be more sensitive to underfunding than overfunding. Through the lens of prospect theory, we first set up a loss-aversion utility function for a sponsor whose utility depends on the funding ratio in each period, obtained from stochastic processes of pension assets and liabilities. We then construct a multi-horizon dynamic control optimization problem to find the optimal investment strategy that maximizes the expected utility of the plan sponsor. A genetic algorithm is employed to provide a numerical solution for our nonlinear dynamic optimization problem. Our results suggest that the overall paths of the optimal equity allocation decline as the age of a plan participant reaches retirement. We also find that the equity portion of the portfolio increases when a sponsor is less loss-averse or the contribution rate is lower.
- Subjects
LOSS aversion; PROSPECT theory; EXPECTED utility; STOCHASTIC processes; GENETIC algorithms; INVESTMENT policy
- Publication
Risks, 2024, Vol 12, Issue 2, p38
- ISSN
2227-9091
- Publication type
Article
- DOI
10.3390/risks12020038