Regret, Portfolio Choice, and Guarantees in Defined Contribution Schemes
WU (Vienna University of Economics and Business); Vienna Graduate School of Finance (VGSF)
Olivia S. Mitchell
University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)
Jacqueline Volkman Wise
Temple University - Risk Management & Insurance & Actuarial Science
Pension Research Council WP2005-17
We model how asset allocation decisions in a defined contribution (DC) pension plan might vary with participants' attitudes about risk and regret. We show that anticipated disutility from regret can have a potent effect on investment choices. Compared to a risk-averse investor, the investor who takes regret into account will hold more stock when the equity premium is low but less stock when the equity premium is high.
We also assess how regret can influence a DC plan participant's view of rate-of-return guarantees, as measured by his willingness-to-pay. We find that regret increases the regret-averse investor's willingness to pay for a guarantee when the portfolio is relatively risky but decreases it when the portfolio is relatively safe.
Number of Pages in PDF File: 18
Date posted: November 2, 2005