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CONTINUOUS-TIME MEAN–VARIANCE OPTIMIZATION FOR DEFINED CONTRIBUTION PENSION FUNDS WITH REGIME-SWITCHING

Research paper by ZHIPING CHEN, LIYUAN WANG, PING CHEN, HAIXIANG YAO

Indexed on: 24 Sep '20Published on: 22 Jul '19Published in: International Journal of Theoretical and Applied Finance



Abstract

International Journal of Theoretical and Applied Finance, Ahead of Print. Using mean–variance (MV) criterion, this paper investigates a continuous-time defined contribution (DC) pension fund investment problem. The framework is constructed under a Markovian regime-switching market consisting of one bank account and multiple risky assets. The prices of the risky assets are governed by geometric Brownian motion while the accumulative contribution evolves according to a Brownian motion with drift and their correlation is considered. The market state is modeled by a Markovian chain and the random regime-switching is assumed to be independent of the underlying Brownian motions. The incorporation of the stochastic accumulative contribution and the correlations between the contribution and the prices of risky assets makes our problem harder to tackle. Luckily, based on appropriate Riccati-type equations and using the techniques of Lagrange multiplier and stochastic linear quadratic control, we derive the explicit expressions of the optimal strategy and efficient frontier. Further, two special cases with no contribution and no regime-switching, respectively, are discussed and the corresponding results are consistent with those results of Zhou & Yin [(2003) Markowitz’s mean-variance portfolio selection with regime switching: A continuous-time model, SIAM Journal on Control and Optimization 42 (4), 1466–1482] and Zhou & Li [(2000) Continuous-time mean-variance portfolio selection: A stochastic LQ framework, Applied Mathematics and Optimization 42 (1), 19–33]. Finally, some numerical analyses based on real data from the American market are provided to illustrate the property of the optimal strategy and the effects of model parameters on the efficient frontier, which sheds light on our theoretical results.