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Paying for Minimum Interest Rate Guarantees: Who Should Compensate Who?
Author(s) -
Jensen Bjarne Astrup,
Sørensen Carsten
Publication year - 2001
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/1468-036x.00152
Subject(s) - interest rate , constraint (computer aided design) , portfolio , set (abstract data type) , economics , fixed interest rate loan , actuarial science , microeconomics , mathematical optimization , computer science , monetary economics , financial economics , mathematics , geometry , programming language
Defined contribution pension schemes often have a mandatory minimum interest rate guarantee as an integrated part of the contract. The guarantee is an embedded put option issued by the institution to the individual who is forced to invest in the option. As argued in this paper, the individual may in this way face a constraint on the feasible set of portfolio choices. We quantify the effect of the minimum interest rate guarantee constraint and demonstrate that guarantees may induce a significant utility loss. We also consider the effects of the interest rate guarantee in the case of heterogenous investors sharing a common portfolio on a pro rata basis.