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THE IMPACT OF INFLATION RISK ON FINANCIAL PLANNING AND RISK-RETURN PROFILES

Published online by Cambridge University Press:  04 February 2014

Stefan Graf ,
Lena Haertel ,
Alexander Kling  and
Jochen Ruß
Stefan Graf*
Affiliation:
Institut für Finanz- und Aktuarwissenschaften (ifa), Ulm, Germany
Lena Haertel
Affiliation:
Ulm University, Ulm, Germany E-Mail: lena.haertel@uni-ulm.de
Alexander Kling
Affiliation:
Institut für Finanz- und Aktuarwissenschaften (ifa), Ulm, Germany E-Mail: a.kling@ifa-ulm.de
Jochen Ruß
Affiliation:
Institut für Finanz- und Aktuarwissenschaften (ifa) and Ulm University, Ulm, Germany E-Mail: j.russ@ifa-ulm.de
*
E-Mail: s.graf@ifa-ulm.de
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Abstract

The importance of funded private or occupational old-age provision is expected to increase due to demographic changes and the resulting problems for government-run pay-as-you-go systems. Clients and advisors therefore need reliable methodologies to match offered products with clients' needs and risk appetite. In Graf et al. (2012), the authors have introduced a methodology based on stochastic modeling to properly assess the risk-return profiles — i.e. the probability distribution of future benefits — of various old-age provision products. In this paper, we additionally consider the impact of inflation on the risk-return profile of old-age provision products. In a model with stochastic interest rates, stochastic inflation and equity returns including stochastic equity volatility, we derive risk-return-profiles for various types of existing unit-linked products with and without embedded guarantees and especially focus on the difference between nominal and real returns. We find that typical “rule of thumb” approximations for considering inflation risk are inappropriate and further show that products that are considered particularly safe by practitioners because of nominal guarantees may bear significant inflation risk. Finally, we propose product designs suitable to reduce inflation risk and investigate their risk-return profile in real terms.

Keywords

Stochastic modelingfinancial planninginflationproduct design
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 44 , Issue 2 , May 2014 , pp. 335 - 365
Copyright
Copyright © ASTIN Bulletin 2014 

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