Benefit Provision in a Cyclic Economy

34 Pages Posted: 16 Mar 2012

See all articles by Renxiang Dai

Renxiang Dai

affiliation not provided to SSRN

Juan Carlos Rodriguez

Tilburg University and CentER

J. M. Schumacher

University of Amsterdam - Department of Quantitative Economics (KE)

Date Written: March 1, 2012

Abstract

We discuss business cycle effects on the management of a trust fund set up to provide regular income on a continuing basis. Fund managers must find a balance between short-term and long-term variability of income. In our model the managers know that the expected return is mean-reverting, but they have limited capability of learning the true current state of the cycle. We consider policies that are optimal under constant relative risk aversion, and we contrast these with a parametric class of policies in which the asset mix is fixed and the estimated business cycle variable is only used in the consumption decision. In a calibration exercise, we find that optimal decisions are based on an exponentially weighted history of past asset returns with a half-time of about seven years. The tradeoff between short-term and long-term variability of income is illustrated by simulation results.

Suggested Citation

Dai, Renxiang and Rodriguez, Juan Carlos and Schumacher, J.M. (Hans), Benefit Provision in a Cyclic Economy (March 1, 2012). Netspar Discussion Paper No. 03/2012-006. Available at SSRN: https://ssrn.com/abstract=2024875 or http://dx.doi.org/10.2139/ssrn.2024875

Renxiang Dai

affiliation not provided to SSRN ( email )

Juan Carlos Rodriguez

Tilburg University and CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 3262 (Phone)
+31 13 466 2875 (Fax)

J.M. (Hans) Schumacher (Contact Author)

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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