Articles from Cass Knowledge

Simple explicit formula for near-optimal stochastic lifestyling

This paper provides a simple formula that captures the main essence of the lifestyling effect.

In life-cycle economics, the Samuelson paradigm states that the optimal investment is in constant proportions out of lifetime wealth composed of current savings and the present value of future income. It is well known that in the presence of credit constraints this paradigm no longer applies. Instead, optimal lifecycle investment gives rise to so-called stochastic lifestyling, whereby for low levels of accumulated capital it is optimal to invest fully in stocks and then gradually switch to safer assets as the level of savings increases. In stochastic lifestyling not only does the ratio between risky and safe assets change but also the mix of risky assets varies over time.

While the existing literature relies on complex numerical algorithms to quantify optimal lifestyling, this paper provides a simple formula that captures the main essence of the lifestyling effect and it does so with remarkable accuracy.

The proposed methodology has been successfully implemented by Allianz DSS – a pension savings provider in Slovakia.

The accepted version of the paper Simple Explicit Formula for Near-Optimal Stochastic Lifestyling can be downloaded at SSRN. The final paper has been accepted for publication in EJOR

A summary document of the paper can be downloaded at the link below, along with a spreadsheet containing the Solver interface.

Attachment(s)

{Simple explicit formula for near-optimal stochastic lifestyling - summary}{https://www.cass.city.ac.uk/__data/assets/pdf_file/0009/510597/simple-explicit-formula-for-near-optimal-stochastic-lifestyling.pdf}; {Solver interface - XLS file}{https://www.cass.city.ac.uk/__data/assets/excel_doc/0007/510595/solver-interface.xlsx}