Hostname: page-component-78c5997874-g7gxr Total loading time: 0 Render date: 2024-11-10T17:30:13.758Z Has data issue: false hasContentIssue false
  • English
  • Français

The Application of Expected-Utility Theory to the Choice of Investment Channels in a Defined-Contribution Retirement Fund

Published online by Cambridge University Press:  09 August 2013

Shaun Levitan  and
Robert Thomson
Shaun Levitan
Affiliation:
Colourfield, PO Box 785535, Sandton, 2146, E-Mail: shaun@levitan.co.za
Robert Thomson
Affiliation:
School of Statistics and Actuarial Science, University of the Witwatersrand, Private Bag 3, Wits, 2050, E-Mail: rthomson@icon.co.za
Get access Rights & Permissions [Opens in a new window]

Abstract

This study examines the practical application of a system for the derivation of member utility functions for the purpose of recommending investment-channel choice to members of a defined-contribution retirement fund. The utility functions of post-retirement benefits from members of a defined-contribution fund are elicited. The risk aversion of each member is measured and the results are compared with a standard risk-tolerance assessment method.

Keywords

Defined contributionInvestment-channel choiceRisk toleranceRisk aversionUtility function
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 39 , Issue 2 , November 2009 , pp. 615 - 647
Copyright
Copyright © International Actuarial Association 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Anderson, J.R., Dillon, J.L. and Hardaker, B. (1977) Agricultural Decision Analysis, Iowa State University Press, Ames; cited in Farquhar (1984) II.5.3.3.Google Scholar
Andrew, J.P. (1994) Risk management in a defined contribution fund. Transactions of the Actuarial Society of South Africa 10(2), 348–420.Google Scholar
Andrew, J.P. (2004) The Conversion of Members' Rights in South African Retirement Funds from Defined Benefits to Defined Contributions and the Statutory Apportionment of the Resulting Actuarial Surplus. South African Actuarial Journal 4, 1–5.Google Scholar
Arts, B. and Vigna, E. (2003) A switch criterion for defined contribution pension schemes. Proceedings of the 13th AFIR Colloquium 1, 261–90.Google Scholar
Bell, D., Raiffa, H. and Tversky, A. (1999) Decision Making: Descriptive, Normative, and Prescriptive Interactions, Cambridge University Press, New York.Google Scholar
Barsky, R., Juster, T., Kimbali, M. and Shapiro, M. (1997) Preference parameters and behavioural heterogeneity: An experimental approach in the Health and Retirement Study. Quarterly Journal of Economics 112(2), 537–539.Google Scholar
Blake, D., Cairns, A. and Dowd, K. (2003) Pension Metrics II: Stochastic pension plan design and value-at-risk during the distribution phase. Insurance: Mathematics and Economics 33, 29–47.Google Scholar
Blake, D., Cairns, A. and Dowd, K. (2001) Pension Metrics: stochastic pension plan design and value-at-risk during the accumulation phase. Insurance: Mathematics and Economics 29, 187–215.Google Scholar
Booth, P.J., Chadburn, R., Haberman, S., James, D. and Cooper, D. (1998) Modern Actuarial Theory and Practice, Chapman & Hall.Google Scholar
Booth, P.M. and Ong, A.S.K. (1994) A simulation based approach to asset allocation. Proceedings of the 4th AFIR Colloquium 1, 217–39.Google Scholar
Bodie, Z. (2004) An Analysis of Investment Advice to Retirement Plan Participants. In Mitchell and Smetters (2004: 19–32).Google Scholar
Daykin, C. (2002) Risk management and regulation of defined contribution schemes. Seminar for Social Security Actuaries and Statisticians: Actuarial Aspects of Pension Reform, Moscow, Russian Federation. Retrieved September 10, 2004, from http://actuaries.org/LIBRARY/other/Moscow_daykin_en.pdf.Google Scholar
Dillman, D.A., Tortora, R.D. and Bowker, D. (1998) Principles for constructing web surveys. SESRC Technical Report, no. 98-50, Pullman, Washington.Google Scholar
Elton, E. and Gruber, M. (1996) Modern Portfolio Theory and Investment Analysis, 5 th edn., John Wiley & Sons, New York.Google Scholar
Faff, R., Mulino, D. and Chai, D. (2008) On the linkage between financial risk tolerance and risk aversion. Journal of Financial Research 31(1), 1–23.Google Scholar
Faculty & Institute of Actuaries (2002) Core Reading: Subject 304, Pensions, Faculty & Institute of Actuaries.Google Scholar
Farquhar, P.H. (1984) Utility assessment methods. Management Science 30, 1283–300.Google Scholar
Grable, J. and Lytton, R. (1999) Financial risk tolerance revisited: The development of a risk assessment instrument. Financial Services Review 8, 63–181.Google Scholar
Grable, J. and Lytton, R. (2003) The development of a risk assessment instrument: a follow-up study. Financial services review 12(3), 257–74.Google Scholar
Hanna, S., Gutter, M. and Fan, J. (2001) A measure of risk aversion based on economic theory. Financial Planning and Counselling 12(2), 53–60.Google Scholar
Hoffmann, L.D. and Bradley, G.L. (1996) Calculus for Business, Economics, and the Social and Life Sciences, 6 th edn., McGraw Hill, New York.Google Scholar
Kamionsky, T. and Bashe, M. (2001) Member investment choice in retirement funds: a conservative look at the choices being made, a moderate approach to categorizing the choices and an aggressive new way to providing choice. Convention, Actuarial Society of South Africa, Johannesburg. Retrieved August 13, 2005, from http://www.assa.org.za/scripts/file_build.asap?id=100000133.Google Scholar
Khorasanee, M.Z. and Smith, D.A. (1997) A utility maximisation approach to individual investment choices in a money purchase pension scheme. Proc. 1997 Investment Conference 2, 261–89.Google Scholar
Leimberg, S.R., Satinsky, M.J., LeClair, R.T. and Doyle, R.J. (eds.) (1993) The tools and techniques of financial planning, 4 th edn., OH: National Underwriter, Cincinnati.Google Scholar
Levitan, S. (unpublished). A practical examination of Thomson's expected utility framework and its application for investment channel choice in defined contribution funds, unpublished M.Sc. research report, University of the Witwatersrand, Johannesburg, 2007.Google Scholar
Lo, A.W. and MacKinlay, C. (2001) Non-Random Walk Down Wall Street, Princeton University Press, New Jersey.Google Scholar
MacCrimmon, K.R. and Wehrung, D.A. (1986) Risk Management, The Free Press, New York.Google Scholar
Mitchell, O.S., Bodie, Z., Brett Hammond, P. and Zeldes, S. (2001) Innovations in Retirement Financing, University of Pennsylvania Press, Philadelphia.Google Scholar
Mitchell, O.S. and Smetters, K. (eds) (2004) The Pensions Challenge: Risk Transfers and Retirement Income Security, Oxford University Press, Oxford, 19–32.Google Scholar
Pratt, J.W. (1964) Risk aversion in the small and in the large. Econometrica 32, 122–36.CrossRefGoogle Scholar
Roszowski, M.J., Snelbecker, G.E. and Leimberg, S.R. (1993) Risk tolerance and risk aversion. In Leimberg, et al. (1993: 213–26).Google Scholar
Schonlau, M., Fricker, R.D. and Elliott, M.N. (2002) Conducting Research Surveys via E-Mail and the Web, Rand Corporation, California.Google Scholar
Thomson, R.J. (2000) An analysis of the utility functions of members of retirement funds. Proceedings of the 10th AFIR International Colloquium, 615–30.Google Scholar
Thomson, R.J. (2003a) The use of utility functions for investment channel choice in a defined contribution retirement funds: I: defence. British Actuarial Journal 9, 653–709.Google Scholar
Thomson, R.J. (2003b) The use of utility functions for investment channel choice in defined contribution retirement funds II: a proposed system. British Actuarial Journal 9(IV), 903–58.Google Scholar
Vigna, E. and Haberman, S. (2001) Optimal investment strategy for defined contribution pension schemes. Insurance: Mathematics and Economics 28, 233–62.Google Scholar
Zavone, J. (2003) Insights – A guide to the good health of member investment choice. Retrieved 7th August, 2005, from https://secure.ampcapital.com.au Google Scholar