Optimal annuity portfolio under inflation risk

Optimal annuity portfolio under inflation risk

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Article ID: iaor201525965
Volume: 12
Issue: 3
Start Page Number: 461
End Page Number: 488
Publication Date: Jul 2015
Journal: Computational Management Science
Authors: , ,
Keywords: optimization, risk, decision, planning, stochastic processes
Abstract:

The paper investigates the importance of inflation‐linked annuities in retirement planning. Given nominal, inflation‐linked, and variable annuities, as well as bonds and stocks, we search for optimal consumption and investment decisions under two different objective functions: (1) maximization of expected utility of real consumption, and (2) minimization of expected deviations from an inflation‐adjusted target. When optimizing the objective, we allow for rebalancing the portfolio during retirement by buying additional annuities and by trading bonds and stocks. To find the optimal solution, we apply a multi‐stage stochastic programming approach. Our findings indicate that independently of the considered objective function, real annuities are a crucial asset in every portfolio. In addition, without investing in real annuities, the retiree has to rebalance the portfolio more frequently, and still obtains a lower and more volatile real consumption.

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