Stochastic Funding of a Defined Contribution Pension Plan with Proportional Administrative Costs and Taxation under Mean-Variance Optimization Approach

Abstract

This paper aim at studying a mean-variance portfolio selection problem with stochastic salary, proportional administrative costs and taxation in the accumulation phase of a defined contribution (DC) pension scheme. The fund process is subjected to taxation while the contribution of the pension plan member (PPM) is tax exempt. It is assumed that the flow of contributions of a PPM are invested into a market that is characterized by a cash account and a stock. The optimal portfolio processes and expected wealth for the PPM are established. The efficient and parabolic frontiers of a PPM portfolios in mean-variance are obtained. It was found that capital market line can be attained when initial fund and the contribution rate are zero. It was also found that the optimal portfolio process involved an inter-temporal hedging term that will offset any shocks to the stochastic salary of the PPM.