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Managing the shortfall risk of target date funds by overfunding

Published online by Cambridge University Press:  10 January 2024

Giovanni Barone Adesi ,
Eckhard Platen  and
Carlo Sala
Giovanni Barone Adesi
Affiliation:
Swiss Finance Institute at Università della Svizzera Italiana (USI), Institute of Finance, Lugano, Switzerland
Eckhard Platen
Affiliation:
School of Mathematical and Physical Sciences and Finance Discipline Group, University of Technology Sydney, Sydney, Australia
Carlo Sala*
Affiliation:
Department of Financial Management and Control, Universitat Ramon Llull, ESADE, Barcelona, Spain
*
Corresponding author: Carlo Sala; Email: carlo.sala@esade.edu
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Abstract

Is it possible to achieve almost riskless, nonfluctuating investment payoffs in the long run, at a fraction of the traditional funding requirement, using equity investments? What is their shortfall risk? These questions are motivated by the need to increase yields, while limiting the variability of investment results. We show how to use contingent claims, denominated in units of a stock index, to achieve an almost riskless investment outcome. To control the risk of the proposed hedge portfolios, we introduce an overfunded scheme and show its reliability using bootstrapping. Results show that a modest amount of overfunding is an effective risk-management approach that brings the probability of not achieving the target to less than 1 percent. Our results are based on the use of the minimal market model and a change of numeraire. Robustness tests support their validity under different market specifications.

Keywords

dynamic investment policyhedginglocally riskless payout

JEL classification

G13: Contingent Pricing • Futures Pricing G14: Information and Market Efficiency • Event Studies • Insider Trading
Type
Article
Information
Journal of Pension Economics & Finance , First View , pp. 1 - 25
Copyright
Copyright © The Author(s), 2024. Published by Cambridge University Press

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