Actuarial Seminar: Debbie Falden (University of Liverpool)

Abstract: An investor's risk aversion is a fundamental element in financial decision-making and preferences but lacks a standardised calibration method. We propose an approach to measure the risk aversion of an investor managing a diverse portfolio that includes pension savings, real estate, and free funds. We utilise the investor's real asset allocation as the optimal strategy, assuming the investor's preferences follow a power utility function (CRRA utility function). We calibrate a risk aversion parameter by building on Merton's formulas for optimal investment strategies. For pension savings, we account for the present value of future premiums, which results in an optimal investment strategy consistent with real life-cycle pension products. Realistic and stable risk aversions are calibrated by constructing a customised risky fund aligned with the investor's preferences. Disparities in risk aversion across financial categories are examined by certainty equivalents, and a numerical study with a real Danish pension portfolio emphasises the practical applications of our results.