Dynamic Portfolio Choice with Annuities when the Interest Rate is Stochastic

Authors: Yannick Dillschneider (Goethe University), Raimond Maurer (Goethe University), Peter Schober (Goethe University)

Title: Dynamic Portfolio Choice with Annuaties when the Interest Rate is Stochastic

Abstract: We analyze optimal investment decisions in stocks, bonds and deferred annuities of households over the lifecycle, when the interest rate is stochastic. Therefore, we set up a lifecycle model with labor income that imposes an affine term structure of interest rates to value deferred annuities and bonds. The short rate in our model is assumed to follow a Cox-Ingersoll-Ross process and the equity risk premium of the stock depends on this short rate. The model is calibrated such that it allows for a correlation of the stock's equity risk premium and the short rate. We solve our model numerically using a discrete time dynamic programming approach.