Lifecycle Consumption-Investment Policies and Pension Plans: A Dynamic Analysis

Journal of Investment Management (JOIM), First Quarter, 2012

Posted: 24 May 2012  

Zvi Bodie

Boston University - Department of Finance & Economics

Jerome Detemple

Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Marcel Rindisbacher

Questrom School of Business, Boston University; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Date Written: May 24, 2012

Abstract

This paper explores the optimal design of personal pensions based on the economic theory of the life cycle. It assumes that individuals derive utility from consumption of goods and leisure and that at some date they retire and stop earning income from labor. The existence of this retirement phase of the life cycle has a profound impact on optimal consumption and portfolio policy. We describe the properties of the optimal pension contract and derive the dynamic trading strategy that hedges the contract. In view of the popularity of age-based strategies — like target date funds — as default options in 401k and other defined contribution retirement plans, some of our results are particularly noteworthy. All target date funds start with a high proportion in equities at a young age and reduce it as a person ages. We identify conditions where the fraction of wealth optimally invested in equities increases or decreases over time as an individual ages. We also analyze the dynamics of pension plans, wealth and optimal policies. Distributional properties of endogenous variables are examined and the robustness of patterns to variations in parameters such as risk aversion and mortality risk is examined.

Keywords: Lifecycle finance, consumption, labor, portfolio, hedging, wealth, pension plan, target-date-funds, dynamic analysis

JEL Classification: G00

Suggested Citation

Bodie, Zvi and Detemple, Jerome and Rindisbacher, Marcel, Lifecycle Consumption-Investment Policies and Pension Plans: A Dynamic Analysis (May 24, 2012). Journal of Investment Management (JOIM), First Quarter, 2012. Available at SSRN: https://ssrn.com/abstract=2066089

Zvi Bodie (Contact Author)

Boston University - Department of Finance & Economics ( email )

United States

HOME PAGE: http://www.zvibodie.com

Jerome Detemple

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 353-4297 (Phone)
(617) 353 6667 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

Marcel Rindisbacher

Questrom School of Business, Boston University ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States
617 353 4152 (Phone)
617 353 999 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

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