Optimal defined contribution pension management with jump diffusions and common shock dependence

TL;DR

This paper develops an optimal asset allocation model for a DC pension plan considering complex stochastic factors like jumps, stochastic volatility, and inflation, providing a closed-form investment strategy.

Contribution

It introduces a novel model incorporating jumps, stochastic volatility, and inflation into pension asset management, deriving a closed-form optimal investment decision.

Findings

Derived a closed-form optimal investment strategy.

Model captures jumps, stochastic volatility, and inflation effects.

Reduces terminal wealth fluctuations in pension funds.

Abstract

This work deals with an optimal asset allocation problem for a defined contribution (DC) pension plan during its accumulation phase. The contribution rate is proportional to the individual's salary, the dynamics of which follows a Heston stochastic volatility model with jumps, and there are common shocks between the salary and the volatility. Since the time horizon of pension management might be long, the influence of inflation is considered in the context. The inflation index is subjected to a Poisson jump and a Brownian uncertainty. The pension plan aims to reduce fluctuations of terminal wealth by investing the fund in a financial market consisting of a riskless asset and a risky asset. The dynamics of the risky asset is given by a jump diffusion process. The closed form of investment decision is derived by the dynamic programming approach.