Optimal annuity portfolio under inflation risk

Agnieszka Karolina Konicz, David Pisinger, Alex Weissensteiner

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    Abstract

    The paper investigates the importance of in ation-linked annuities to individuals facing in ation risk. Given the investment opportunities in nominal, real, and variable annuities, as well as cash and stocks, we investigate the consumption and investment decisions under two different objective functions:
    1) maximization of the expected CRRA utility function, and 2) minimization of squared deviations from an in ation-adjusted target. To find the optimal decisions we apply a multi-stage stochastic programming approach. Our findings indicate that independently of the considered objective function and risk aversion, 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 the lower and more volatile real consumption.
    Original languageEnglish
    JournalComputational Management Science
    Volume12
    Issue number3
    Pages (from-to)461-488
    ISSN1619-697X
    DOIs
    Publication statusPublished - 2015

    Keywords

    • Inflation-linked annuity
    • Retirement planning
    • CRRA utility
    • Loss disutility
    • Multi-stage stochastic programming

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