Hedging Longevity Risk in Defined Contribution Pension Schemes

31 Pages Posted: 10 Mar 2020 Last revised: 21 May 2020

See all articles by Ankush Agarwal

Ankush Agarwal

affiliation not provided to SSRN

Christian-Oliver Ewald

University of Glasgow; Høgskole i Innlandet

Yongjie Wang

University of Glasgow

Date Written: April 15, 2019

Abstract

Pension schemes all over the world are under increasing pressure to efficiently hedge the longevity risk posed by ageing populations. In this work, we study an optimal investment problem for a defined contribution pension scheme which decides to hedge the longevity risk using a mortality-linked security, typically a longevity bond. The pension scheme invests in the risky assets available in the market, including the longevity bond, by using the contributions from a representative scheme member to ensure a minimum guarantee such that the member is able to purchase a lifetime annuity upon retirement. We transform this constrained optimal investment problem into an unconstrained problem by replicating a self-financing portfolio of future contributions from the member and the minimum guarantee provided by the scheme. We solve the resulting optimisation problem using the dynamic programming principle and through a series of numerical studies reveal that the longevity risk has an important impact on the performance of investment strategies. Our results provide mathematical evidence supporting the use of mortality-linked securities for efficient hedging of the longevity risk.

Keywords: defined contribution pension scheme, longevity bond, stochastic control, dynamic programming principle

JEL Classification: G10, G11, G12, G22

Suggested Citation

Agarwal, Ankush and Ewald, Christian-Oliver and Wang, Yongjie, Hedging Longevity Risk in Defined Contribution Pension Schemes (April 15, 2019). Available at SSRN: https://ssrn.com/abstract=3539724 or http://dx.doi.org/10.2139/ssrn.3539724

Ankush Agarwal

affiliation not provided to SSRN

Christian-Oliver Ewald

University of Glasgow ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

Høgskole i Innlandet ( email )

Lillehammer, 2624
Norway

Yongjie Wang (Contact Author)

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

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