Housing Equity Withdrawal in the Portfolio Choice for Deferred Pension Income

Abstract

The paper examines the optimal structure of retirement incomes from the perspective of the young pessimistic decision maker, i.e. a young employee who can invest in different pension funds or in residential property and who is exposed to volatility of interest rate. After a worldwide shift from defined benefit (DB) systems to defined contribution (DC) schemes, these risks are squarely on the workers’ shoulders, as also explained in the recently published CEJOR paper of Di Giacinto and Vigna. Therefore, the risks should be mitigated by a proper portfolio structure. Because occupational and private pension incomes decrease with the decreasing interest rate, the only available investment strategy to mitigate these risks is to invest also in the assets whose cash flow is negatively correlated with the interest rate. Therefore the advantage to invest in one’s own home to be able to participate later, i.e. after retirement, in Equity Release Schemes (ERS) is highlighted and the optimal structure of pension incomes is derived.