**DISCUSSION PAPER PI-0811**

Optimal Pension Asset Allocation Strategy for Defined-contribution Plans with Exponential Utility

Qing-Ping Ma

This paper considers the asset allocation strategies for members of

defined-contribution pension plans with exponential utility when there are
three types

of asset, cash, bonds and stocks. The portfolio problem is to maximize the
expected

utility of terminal wealth that uses the plan member’s final wage as
a numeraire, in

the presence of three risk sources, interest risk, asset risk and wage risk.
The use of a

stochastic numeraire makes usual riskless cash assets risky. A closed form
solution is

found for the asset allocation problem when a portfolio replicates exactly
the wage

process exists, which is the true riskless asset. The optimal portfolio composition
is

horizon dependent, while the investments in the three asset classes have constant

wealth-to-wage ratios. The paper discusses the implication of using wage as

numeraire and assuming exponential utility function in portfolio and pension

investment strategy studies.

Keywords : Defined-contribution pension plan; Wage risk; Optimal asset allocation;

Exponential utility; Hamilton-Jacobi-Bellman equation.