IDEAS home Printed from https://ideas.repec.org/a/gam/jrisks/v10y2022i1p15-d719425.html
   My bibliography  Save this article

Optimal Asset Allocation Subject to Withdrawal Risk and Solvency Constraints

Author

Listed:
  • Areski Cousin

    (Institut de Recherche en Mathématique Avancée, Université de Strasbourg, 7 rue René Descartes, 67084 Strasbourg, France
    These authors contributed equally to this work.)

  • Ying Jiao

    (Institut de Science Financière et d’Assurances, Université Claude Bernard Lyon 1, 50 Avenue Tony Garnier, 69007 Lyon, France
    These authors contributed equally to this work.)

  • Christian Yann Robert

    (ENSAE IPP, 5 Avenue Le Chatelier, 91120 Palaiseau, France
    These authors contributed equally to this work.)

  • Olivier David Zerbib

    (Finance Department, Questrom School of Business, Boston University, 595 Commonwealth Avenue, Boston, MA 02215, USA
    These authors contributed equally to this work.)

Abstract

This paper investigates the optimal asset allocation of a financial institution whose customers are free to withdraw their capital-guaranteed financial contracts at any time. In accounting for the asset-liability mismatch risk of the institution, we present a general utility optimization problem in a discrete-time setting and provide a dynamic programming principle for the optimal investment strategies. Furthermore, we consider an explicit context, including liquidity risk, interest rate, and credit intensity fluctuations, and show by numerical results that the optimal strategy improves both the solvency and asset returns of the institution compared to a standard institutional investor’s asset allocation.

Suggested Citation

  • Areski Cousin & Ying Jiao & Christian Yann Robert & Olivier David Zerbib, 2022. "Optimal Asset Allocation Subject to Withdrawal Risk and Solvency Constraints," Risks, MDPI, vol. 10(1), pages 1-28, January.
    • Handle: RePEc:gam:jrisks:v:10:y:2022:i:1:p:15-:d:719425
    as

    Download full text from publisher

    File URL: https://www.mdpi.com/2227-9091/10/1/15/pdf
    Download Restriction: no
    File URL: https://www.mdpi.com/2227-9091/10/1/15/
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Michael W. Brandt & Amit Goyal & Pedro Santa-Clara & Jonathan R. Stroud, 2005. "A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability," The Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 831-873.
    2. Phelim Boyle & Weidong Tian, 2007. "Portfolio Management With Constraints," Mathematical Finance, Wiley Blackwell, vol. 17(3), pages 319-343, July.
    3. Cousin, Areski & Jiao, Ying & Robert, Christian Y. & Zerbib, Olivier David, 2016. "Asset allocation strategies in the presence of liability constraints," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 327-338.
    4. Frauendorfer, Karl & Schurle, Michael, 2003. "Management of non-maturing deposits by multistage stochastic programming," European Journal of Operational Research, Elsevier, vol. 151(3), pages 602-616, December.
    5. Shevchenko, Pavel V. & Luo, Xiaolin, 2017. "Valuation of variable annuities with Guaranteed Minimum Withdrawal Benefit under stochastic interest rate," Insurance: Mathematics and Economics, Elsevier, vol. 76(C), pages 104-117.
    6. Jack Bao & Jun Pan & Jiang Wang, 2011. "The Illiquidity of Corporate Bonds," Journal of Finance, American Finance Association, vol. 66(3), pages 911-946, June.
    7. Chen, Tsung-Kang & Liao, Hsien-Hsing & Tsai, Pei-Ling, 2011. "Internal liquidity risk in corporate bond yield spreads," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 978-987, April.
    8. Dick-Nielsen, Jens & Feldhütter, Peter & Lando, David, 2012. "Corporate bond liquidity before and after the onset of the subprime crisis," Journal of Financial Economics, Elsevier, vol. 103(3), pages 471-492.
    9. Gundel, Anne & Weber, Stefan, 2007. "Robust utility maximization with limited downside risk in incomplete markets," Stochastic Processes and their Applications, Elsevier, vol. 117(11), pages 1663-1688, November.
    10. Romain Blanchard & Laurence Carassus, 2018. "Multiple-Priors Optimal Investment In Discrete Time For Unbounded Utility Function," Working Papers hal-01883787, HAL.
    11. El Karoui, Nicole & Jeanblanc, Monique & Lacoste, Vincent, 2005. "Optimal portfolio management with American capital guarantee," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 449-468, March.
    12. Pavel V. Shevchenko & Xiaolin Luo, 2016. "Valuation of Variable Annuities with Guaranteed Minimum Withdrawal Benefit under Stochastic Interest Rate," Papers 1602.03238, arXiv.org, revised Jan 2017.
    13. Jan Ericsson & Olivier Renault, 2006. "Liquidity and Credit Risk," Journal of Finance, American Finance Association, vol. 61(5), pages 2219-2250, October.
    14. Steinorth, Petra & Mitchell, Olivia S., 2015. "Valuing variable annuities with guaranteed minimum lifetime withdrawal benefits," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 246-258.
    15. Ying Jiao & Olivier Klopfenstein & Peter Tankov, 2017. "Hedging under multiple risk constraints," Finance and Stochastics, Springer, vol. 21(2), pages 361-396, April.
    16. Kalkbrener, Michael & Willing, Jan, 2004. "Risk management of non-maturing liabilities," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1547-1568, July.
    17. Peter Carr & Vadim Linetsky, 2006. "A jump to default extended CEV model: an application of Bessel processes," Finance and Stochastics, Springer, vol. 10(3), pages 303-330, September.
    18. Wang, JinDong & Xu, Wei, 2020. "Risk-Based Capital For Variable Annuity Under Stochastic Interest Rate," ASTIN Bulletin, Cambridge University Press, vol. 50(3), pages 959-999, September.
    19. Lin, X. Sheldon & Yang, Shuai, 2020. "Fast and efficient nested simulation for large variable annuity portfolios: A surrogate modeling approach," Insurance: Mathematics and Economics, Elsevier, vol. 91(C), pages 85-103.
    20. Areski Cousin & Ying Jiao & Christian Robert & Olivier David Zerbib, 2016. "Asset allocation strategies in the presence of liability constraints," Post-Print halshs-02008642, HAL.
    21. Duffie, Darrell, 2005. "Credit risk modeling with affine processes," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2751-2802, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Benjamín Vallejo-Jiménez & Francisco Venegas-Martínez & Oscar V. De la Torre-Torres & José Álvarez-García, 2022. "Simulating Portfolio Decisions under Uncertainty When the Risky Asset and Short Rate Are Modulated by an Inhomogeneous and Asset-Dependent Markov Chain," Mathematics, MDPI, vol. 10(16), pages 1-14, August.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Zhou, Yimin & Wei, Xu, 2023. "Bond liquidity, debt maturity and bond risk premium," Finance Research Letters, Elsevier, vol. 54(C).
    2. Cousin, Areski & Jiao, Ying & Robert, Christian Y. & Zerbib, Olivier David, 2016. "Asset allocation strategies in the presence of liability constraints," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 327-338.
    3. Black, Jeffrey R. & Stock, Duane & Yadav, Pradeep K., 2016. "The pricing of different dimensions of liquidity: Evidence from government guaranteed bonds," Journal of Banking & Finance, Elsevier, vol. 71(C), pages 119-132.
    4. Kirkby, J. Lars & Nguyen, Duy, 2021. "Equity-linked Guaranteed Minimum Death Benefits with dollar cost averaging," Insurance: Mathematics and Economics, Elsevier, vol. 100(C), pages 408-428.
    5. Goldstein, Michael A. & Namin, Elmira Shekari, 2023. "Corporate bond liquidity and yield spreads: A review," Research in International Business and Finance, Elsevier, vol. 65(C).
    6. Díaz, Antonio & Escribano, Ana, 2022. "Liquidity dimensions in the U.S. corporate bond market," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 1163-1179.
    7. Ying Jiao & Olivier Klopfenstein & Peter Tankov, 2013. "Hedging under multiple risk constraints," Papers 1309.5094, arXiv.org.
    8. Pelizzon, Loriana & Subrahmanyam, Marti G. & Tomio, Davide & Uno, Jun, 2016. "Sovereign credit risk, liquidity, and European Central Bank intervention: Deus ex machina?," Journal of Financial Economics, Elsevier, vol. 122(1), pages 86-115.
    9. Okou, Cedric & Maalaoui Chun, Olfa & Dionne, Georges & Li, Jingyuan, 2016. "Can Higher-Order Risks Explain the Credit Spread Puzzle?," Working Papers 16-1, HEC Montreal, Canada Research Chair in Risk Management.
    10. Niu, Huawei & Hua, Wei, 2019. "An endogenous structural credit risk model incorporating with moral hazard and rollover risk," Economic Modelling, Elsevier, vol. 78(C), pages 47-59.
    11. Abudy, Menachem Meni & Raviv, Alon, 2016. "How much can illiquidity affect corporate debt yield spread?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 58-69.
    12. Markus Herrmann & Martin Hibbeln, 2023. "Trading and liquidity in the catastrophe bond market," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 90(2), pages 283-328, June.
    13. Song Han & Hao Zhou, 2016. "Effects of Liquidity on the Non-Default Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(03), pages 1-49, September.
    14. Ying Jiao & Olivier Klopfenstein & Peter Tankov, 2017. "Hedging under multiple risk constraints," Finance and Stochastics, Springer, vol. 21(2), pages 361-396, April.
    15. Bethke, Sebastian & Kempf, Alexander & Trapp, Monika, 2014. "Investor sentiment, flight-to-quality, and corporate bond comovement," CFR Working Papers 13-06 [rev.], University of Cologne, Centre for Financial Research (CFR).
    16. Wei, Xu & Xiao, Xiao & Zhou, Yi & Zhou, Yimin, 2023. "Spillover effects between liquidity risks through endogenous debt maturity," Journal of Financial Markets, Elsevier, vol. 64(C).
    17. Adachi-Sato, Meg & Vithessonthi, Chaiporn, 2019. "Corporate debt maturity and future firm performance volatility," International Review of Economics & Finance, Elsevier, vol. 60(C), pages 216-237.
    18. De Franco, Carmine & Tankov, Peter, 2011. "Portfolio insurance under a risk-measure constraint," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 361-370.
    19. Géraldine Bouveret, 2018. "Portfolio Optimization Under A Quantile Hedging Constraint," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(07), pages 1-36, November.
    20. Díaz, Antonio & Escribano, Ana, 2020. "Measuring the multi-faceted dimension of liquidity in financial markets: A literature review," Research in International Business and Finance, Elsevier, vol. 51(C).

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jrisks:v:10:y:2022:i:1:p:15-:d:719425. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: MDPI Indexing Manager (email available below). General contact details of provider: https://www.mdpi.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.