Cushion option on CPPI strategy for defined-contribution pension plans

Gulveren A., TEMOÇİN B. Z., KESTEL A. S.

Journal of Pension Economics and Finance, 2025 (SSCI, Scopus) identifier identifier

  • Yayın Türü: Makale / Tam Makale
  • Basım Tarihi: 2025
  • Doi Numarası: 10.1017/s147474722500006x
  • Dergi Adı: Journal of Pension Economics and Finance
  • Derginin Tarandığı İndeksler: Social Sciences Citation Index (SSCI), Scopus, ABI/INFORM, Business Source Elite, Business Source Premier, EconLit
  • Anahtar Kelimeler: CPPI strategy, defined contribution pension plan, exotic (cushion) option, portfolio allocation, risk management
  • Orta Doğu Teknik Üniversitesi Adresli: Evet

Özet

This paper investigates a well-known downside protection strategy called the constant proportion portfolio insurance (CPPI) in defined contribution (DC) pension fund modeling. Under discrete time trading CPPI, an investor faces the risk of portfolio value hitting the floor which denotes the process of guaranteed portfolio values. In this paper, we question how to deal with so-called 'gap risk' which may appear due to uncontrollable events resulting in a sudden drop in the market. In the market model considered, the risky asset price and the labor income are assumed to be continuous-time stochastic processes, whereas trading is restricted to discrete-time. In this setting, an exotic option (namely, the 'cushion option') is proposed with the aim of reducing the risk that the portfolio value falls below the defined floor. We analyze the effectiveness of the proposed exotic option for a DC plan CPPI strategy through Monte Carlo simulations and sensitivity analyses with respect to the parameters reflecting different setups.