Optimal Collective Investment: The Impact of Sharing Rules, Management Fees and Guarantees
49 Pages Posted: 20 Sep 2018 Last revised: 25 Jan 2020
Date Written: January 23, 2020
Many pension beneficiaries are reluctant to give up guaranteed payments, as they believe that their benefits will deteriorate through this. In the present article, we design and solve an optimal collective investment problem under a guarantee constraint. In this problem, we incorporate heterogeneous risk preferences of individual plan members, whose importance has recently been addressed in Alserda et al. (2019). We distinguish between two types of investors (with different willingness to pay management fees) and study the impact of guarantees, sharing rules and management fees on the individual investors' benefits. Regarding the guarantees, we find that requiring deterministic guarantees deteriorates the benefits of investors with different risk aversions in both groups. A flexible guarantee which consists of a deterministic and a state-dependent component turns out to serve each investor's risk appetite in a much better way than the deterministic guarantee. To decently achieve fairness among various investors, careful considerations shall be given to the design of the sharing rule.
Keywords: Collective investment problems, guarantee design, risk sharing
JEL Classification: G11, G23
Suggested Citation: Suggested Citation