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A general question with respect to the design of an investment strategy for a retirement fund.
I have read reference material which mentions that one approach to developing such a strategy is to identify the desired payoff function at retirement of the relevant individual or group and to use option pricing techniques to derive the investment strategy that provides this outcome.
I struggle to make a direct connection between option pricing and the derivation of the investment strategy.
It seems sensible that the optimal investment strategy would be that which replicates the desired payoff. Determining the current price of the desired payoff follows directly from this.
The material I am referencing lists the following steps:
For the purpose of determining an optimal investment strategy, I would have described the process as:
I have read reference material which mentions that one approach to developing such a strategy is to identify the desired payoff function at retirement of the relevant individual or group and to use option pricing techniques to derive the investment strategy that provides this outcome.
I struggle to make a direct connection between option pricing and the derivation of the investment strategy.
It seems sensible that the optimal investment strategy would be that which replicates the desired payoff. Determining the current price of the desired payoff follows directly from this.
The material I am referencing lists the following steps:
- Derive the optimal payoff function of the investor's pension plan as a function of the asset prices at that time;
- Price the investor's desired payoff function using standard option pricing techniques; and
- Determine the replicating portfolio of the investor's desired payoff function using the delta method or an alternative.
For the purpose of determining an optimal investment strategy, I would have described the process as:
- Identify the desired payoff function; and
- Determine the replicating portfolio and hence price.