Preprint Article Version 1 This version not peer reviewed

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

Version 1 : Received: 23 January 2018 / Approved: 25 January 2018 / Online: 25 January 2018 (09:17:12 CET)

How to cite: Zhang, X.; Guo, J. The Role of Inflation-indexed Bond in Optimal Management of Defined Contribution Pension Plan During the Decumulation Phrase. Preprints 2018, 2018010239 (doi: 10.20944/preprints201801.0239.v1). Zhang, X.; Guo, J. The Role of Inflation-indexed Bond in Optimal Management of Defined Contribution Pension Plan During the Decumulation Phrase. Preprints 2018, 2018010239 (doi: 10.20944/preprints201801.0239.v1).

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.

Subject Areas

inflation-indexed bond; DC pension plan; stochastic optimal control; dynamic programming approach; HJB equation.

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