Hostname: page-component-8448b6f56d-42gr6 Total loading time: 0 Render date: 2024-04-18T21:09:53.326Z Has data issue: false hasContentIssue false
  • English
  • Français

Lifecycle derivatives and retirement income assurance using long-term debt

Published online by Cambridge University Press:  06 December 2007

ROGER J. BOWDEN
ROGER J. BOWDEN
Affiliation:
School of Economics and Finance, Victoria University of Wellington and Kiwicap Research Ltd, WellingtonNew Zealand (e-mails:roger.bowden@vuw.ac.nz; roger.bowden@kiwicap.co.nz; fax:+64 4 472 4983)
Get access Rights & Permissions [Opens in a new window]

Abstract

As life tables continue to lengthen, a world-wide paradigm shift to defined contribution – but undefined rewards – has left pensioners exposed to performance, credit, and longevity risk. However, relatively risk-free defined benefit schemes can be designed off the back of high-grade debt issuance programmes by public long-term asset vehicles, as an infrastructure–retirement double play. Derivatives can be used to enhance coupons and to correctly align risk preferences as between income while still alive and bequests. Variable lifetime reinvested coupon options and annuity swaps utilize market pricing to provide unambiguous pricing benchmarks and a necessary underpinning of lifecycle planning certainty. The result is a flexible mix of private and public provision of old age income assurance, one that exploits the externalities of a well-designed system of public debt.

Type
Articles
Information
Journal of Pension Economics & Finance , Volume 8 , Issue 3 , July 2009 , pp. 361 - 390
Copyright
Copyright © 2007 Cambridge University Press

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

Ball, C. A. and Torous, W. N. (1999) The stochastic volatility of interest rates: some international evidence. Journal of Finance, 54: 2339–2359.CrossRefGoogle Scholar
Barone-Adesi, G. and Whaley, R. E. (1987) Efficient analytic approximation of American option values. Journal of Finance, 42: 301–320.CrossRefGoogle Scholar
Barsky, R. B., Juster, F. T., Kimball, M. S., and Shapiro, M. D. (1997) Preference parameters and behavioural heterogeneity: an experimental approach in the Health and Retirement Survey. Quarterly Journal of Economics, 107: 537–580.CrossRefGoogle Scholar
Black, F. (1976) The pricing of commodity contracts. Journal of Financial Economics, 3: 167–179.CrossRefGoogle Scholar
Bowden, R. J. (2006) The generalised value at risk admissible set: constraint consistency and portfolio outcomes. Quantitative Finance, 6: 159–171.CrossRefGoogle Scholar
Briys, E., Bellalah, M., Mai, H. M., and de Varenne, F. (1998) Options, Futures and Exotic Derivatives: Theory, Applications and Practice, Chichester, NY: Wiley.Google Scholar
Brown, J. R., Mitchell, O. S., Poterba, J. R., and Warshawsky, M. J. (2001) The Role of Financial Markets in Financing Retirement, Cambridge, MA: MIT Press.Google Scholar
Brown, J. R., Mitchell, O. S., and Poterba, J. R. (2001) The role of real annuities and index bonds in an individual retirement program. In Brown, (ibid.).CrossRefGoogle Scholar
Chacko, G. and Das, S. (2002) Pricing interest rate derivatives: a general approach. Review of Financial Studies, 15: 195–241.CrossRefGoogle Scholar
Cox, J. C., Ingersoll, J., and Ross, S. A. (1985) A theory of the term structure of interest rates. Econometrica, 53: 385–407.CrossRefGoogle Scholar
Duffie, D. and Singleton, K. (1999) Modeling term structures of defaultable bonds. Review of Financial Studies, 12: 687–720.CrossRefGoogle Scholar
Duffie, D. (1996) Dynamic Asset Pricing Theory, 2nd edn, Princeton, NJ: Princeton University Press.Google Scholar
Fabozzi, F. J. (2002) Fixed Income Securities, 2nd edn, New York: Wiley.Google Scholar
Firodia, A. (2005) Money illusion: plenty of funds available for infrastructure. Times of India, 1 February, New Delhi.Google Scholar
Fisher, S. (1973) A lifecycle model with life insurance purchase. International Economic Review, 10: 443–466.Google Scholar
Gavrilov, L. A. and Gavrilova, N. S. (1991) The Biology of Life Span: A Quantitative Approach, New York: Harwood Academic.Google Scholar
Heath, D., Jarrow, R., and Morton, A. (1992) Bond pricing and the term structure of interest rates: a new methodology for contingent claims valuation. Econometrica, 60: 77–105.CrossRefGoogle Scholar
Heston, S. (1993) Invisible parameters in option prices. Journal of Finance, 48: 933–947.CrossRefGoogle Scholar
Hoffman, N., Platen, E., and Schweizer, M. (1992) Option pricing under incompleteness and stochastic volatility. Mathematical Finance, 2: 153–187.CrossRefGoogle Scholar
Jensen, M. C. (1986) Agency costs of free cash flow, corporate finance and takeovers. American Economic Review, 76: 1986.Google Scholar
Merton, R. C. (1969) Optimal consumption and portfolio rules in a continuous time model. Journal of Economic Theory, 3: 373–413.CrossRefGoogle Scholar
Mitchell, O. S., Poterba, J. R., Warshawsky, M. J., and Brown, J. R. (2001) New evidence on the money's worth of individual annuities. In Brown, (ibid.).Google Scholar
Richard, S. F. (1975) Optimal consumption, portfolio and life insurance rules for an uncertain lived individual in a continuous time model. Journal of Financial Economics, 2: 187–203.CrossRefGoogle Scholar
Securities and Exchange Commission, US (2004) Variable annuities: what you should know. www.sec/govt/investor/pubs/varannuity.Google Scholar
Sutcliffe, C. (2005) The cult of the equity for pension funds: should it get the boot? Journal of Pension Economics and Finance, 4(1): 57–85.CrossRefGoogle Scholar