Journal of Risk

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Optimal asset management for defined-contribution pension funds with default risk

Shibo Bian, James Cicon and Yi Zhang

  • An optimal pension management problem with default risk is considered.
  • The optimization problem is studied in a jump-diffusion framework.
  • Optimal strategies for CRRA utility are derived explicitly.

ABSTRACT

We explore how a defined-contribution pension fund optimally distributes wealth between a defaultable bond, a stock and a bank account, given that a salary is a stochastic process. We assume that the investment objective of the defined-contribution pension fund is to maximize the expected constant relative risk aversion utility of terminal wealth. We thus obtain a closed-form solution to the optimal problem using a martingale approach. We develop numerical simulations, which we graph as illustrations. Finally, we discuss relevant economic insights obtained from our results.

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