Optimal asset allocation for DC pension plans under inflation

In this paper, the stochastic dynamic programming approach is used to investigate the optimal asset allocation for a defined-contribution pension plan with downside protection under stochastic inflation. The plan participant invests the fund wealth and the stochastic interim contribution flows into the financial market. The nominal interest rate model is described by the Cox–Ingersoll–Ross (Cox et al., 1985) dynamics. To cope with the inflation risk, the inflation indexed bond is included in the asset menu. The retired individuals receive an annuity that is indexed by inflation and a downside protection on the amount of this annuity is considered. The closed-form solution is derived under the CRRA utility function. Finally, a numerical application is presented to characterize the dynamic behavior of the optimal investment strategy. ► We model the optimal asset allocation for DC pension plan under inflation. ► A minimum guarantee on the amount of retirement annuity is considered. ► We emphasize the importance of the inflation-indexed bond in the pension portfolio. ► The investments in indexed bonds would increase with the risk-aversion. ► The investments in indexed bonds would increase with the guarantee provided.