How can defined contribution pension plans benefit from momentum and mean reversion?

Abstract

In this paper, we assess whether the stock market downturn can be an opportunity for Defined Contribution pension plan members to reinforce their risky assets exposure? In line with the framework developed by Kojein et al. (Manag Sci 55 (7):1199-1213, 2009), we consider a DC plan investor, during the accumulation phase, whose aim is to maximize his terminal wealth. Within a continuous portfolio choice model, in which stock returns exhibit both momentum and mean reversion, DC plan members are allowed to invest their pension wealth into stocks as well as cash and bond assets. We derived the optimal portfolio candidate and we show how a DC plan investor can benefit from market opportunities by taking advantage of the momentum and mean reversion stock return properties. We find that long term investors such as DC plan members would benefit from a temporary increase of the share of risky assets in their portfolio in preparation of their retirement.