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EURO Advanced Tutorials on Operational Research
Series Editors: M. Grazia Speranza · José Fernando Oliveira

Francesco Menoncin

Risk Management
for Pension Funds
A Continuous Time Approach
with Applications in R
EURO Advanced Tutorials on Operational
Research

Series Editors
M. Grazia Speranza, Brescia, Italy
José Fernando Oliveira, Porto, Portugal
The EURO Advanced Tutorials on Operational Research are a series of short books
devoted to an advanced topic—a topic that is not treated in depth in available
textbooks. The series covers comprehensively all aspects of Operations Research.
The scope of a Tutorial is to provide an understanding of an advanced topic to young
researchers, such as Ph.D. students or Post-docs, but also to senior researchers and
practitioners. Tutorials may be used as textbooks in graduate courses.

More information about this series at http://www.springer.com/series/13840

Francesco Menoncin

Risk Management
for Pension Funds
A Continuous Time Approach
with Applications in R
Francesco Menoncin
Department of Economics and Management
University of Brescia
Brescia, Italy

ISSN 2364-687X ISSN 2364-6888 (electronic)

EURO Advanced Tutorials on Operational Research
ISBN 978-3-030-55527-6 ISBN 978-3-030-55528-3 (eBook)
https://doi.org/10.1007/978-3-030-55528-3

© Springer Nature Switzerland AG 2021

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Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 1
1.1 The Structure of the Book .. . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 4
1.2 The R Software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 5
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 8
2 Decision Theory Under Uncertainty . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 11
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 11
2.2 Decision Theory (Without Risk) . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 11
2.3 Decision Theory (With Risk) . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 13
2.4 Critics to the Expected Utility . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 16
2.5 Risk Aversion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 18
2.6 The Stone–Geary Utility Function .. . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 24
2.7 Certainty Equivalent on Financial Markets . . . . . . .. . . . . . . . . . . . . . . . . . . . 25
2.8 Utility and Time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 29
2.9 A First Pension Model.. . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 31
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 36
3 Stochastic Processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 37
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 37
3.2 Deterministic Linear Differential Equation.. . . . . .. . . . . . . . . . . . . . . . . . . . 37
3.3 Stochastic Linear Differential Equation . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 38
3.4 Stochastic Models Used in Finance .. . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 41
3.5 Parameter Estimation .. . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 43
3.6 The Interest Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 45
3.7 Simulation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 51
3.8 The State Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 53
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 55
4 The Financial Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 57
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 57
4.2 Financial Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 57
4.3 Portfolio and Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 58

v
vi Contents

4.4 External Cash Flows and Modified Wealth . . . . . . .. . . . . . . . . . . . . . . . . . . . 61

4.5 Arbitrage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 62
4.6 Completeness (and Asset Pricing) . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 66
4.7 Change of Probability and Asset Pricing . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 69
4.8 Bond Pricing: Closed Form and Simulations. . . . .. . . . . . . . . . . . . . . . . . . . 72
4.9 The Switch Between Probabilities . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 76
4.10 Change of Numéraire .. . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 79
4.11 Assets with Coupons/Dividends . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 80
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 82
5 The Actuarial Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 83
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 83
5.2 Actuarial Measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 83
5.3 Double Stochastic Force of Mortality and Asset Pricing . . . . . . . . . . . . 86
5.4 Annuities in the Gompertz Framework .. . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 89
5.5 The Human Mortality Database. . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 94
5.6 Estimation of the Gompertz Deterministic Model . . . . . . . . . . . . . . . . . . . 96
5.7 A Stochastic Model for the Force of Mortality .. .. . . . . . . . . . . . . . . . . . . . 100
5.8 A Stochastic Model for the Survival Probability .. . . . . . . . . . . . . . . . . . . . 107
5.9 The Evolution of Wealth Subject to Actuarial Risk . . . . . . . . . . . . . . . . . . 109
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 111
6 Financial-Actuarial Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 113
6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 113
6.2 Derivatives on Human Life.. . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 113
6.3 Longevity Bond .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 116
6.4 The Tontine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 117
6.5 Death Bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 119
Reference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 122
7 Pension Fund Management .. . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 123
7.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 123
7.2 Contributions and Pensions . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 123
7.3 Reserves .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 128
7.4 Prospective Mathematical Reserve . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 129
7.5 Fund’s Budget Constraint . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 133
7.6 Pension Fund’s Ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 136
7.7 Fund’s Optimisation Problem .. . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 137
7.8 Dynamic Optimisation (the Martingale Approach) . . . . . . . . . . . . . . . . . . 138
7.9 The Optimal Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 144
7.10 The Speculative Portfolio Component .. . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 146
7.11 The Speculative Portfolio Component: A Numerical Example . . . . . 148
7.12 Hedging Portfolio Component for Minimum Wealth . . . . . . . . . . . . . . . . 152
7.13 Hedging Portfolio Component for Prospective Mathematical
Reserve .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 153
7.14 Hedging Portfolio Component for Discount Factor .. . . . . . . . . . . . . . . . . 154
Contents vii

7.15 The Case of an Incomplete Market . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 158

7.16 The Role of Longevity Bonds and Ordinary Bonds.. . . . . . . . . . . . . . . . . 160
7.17 The Role of Longevity Bonds and Ordinary Bonds in an
Incomplete Market.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 164
7.18 The Inflation Risk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 166
Reference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 168
8 A Workable Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 169
8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 169
8.2 The State Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 169
8.3 The Auxiliary Functions.. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 172
8.4 The Financial Market .. . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 178
8.5 The Data.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 180
8.6 Calibration of the Riskless Interest Rate. . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 184
8.7 Calibration of the ZCB . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 185
8.8 Calibration of the Risky Asset . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 186
8.9 Calibration of the Contributions . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 189
8.10 The Behaviour of the Auxiliary Functions . . . . . . .. . . . . . . . . . . . . . . . . . . . 191
8.11 The Derivatives of the Auxiliary Functions . . . . . .. . . . . . . . . . . . . . . . . . . . 201
8.12 The Simulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 209
8.13 The Optimal Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 216
9 A Pure Accumulation Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 227
9.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 227
9.2 The Optimisation Problem . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 227
9.3 The Optimal Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 228
9.4 A Workable Framework . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 230
9.5 The Optimal Portfolio: Numerical Results . . . . . . .. . . . . . . . . . . . . . . . . . . . 232

Conclusions .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . 239
Chapter 1
Introduction

Since the seminal papers of Markowitz (1952) and Merton (1969, 1971), the
literature about optimal asset allocation and risk management has been developing
fast and now takes into account many possible frameworks and applications. Here,
we deal with the application of the asset allocation problem to a more recent topic:
the pension funds.
Unlike analyses dedicated to non-actuarial institutional investors (a general
framework can be found, for instance, in Lioui and Poncet 2001), the case of a
pension fund requires the introduction of two new characteristics: (1) the different
behaviour of the fund wealth during the accumulation phase (hereafter APh) when
contributions are paid by the member and the distribution phase (hereafter DPh)
when the pension is paid to the member, and (2) the mortality risk.
The link between contributions and pensions can be established inside one of
the two following frameworks: the so-called defined-benefit pension plan (hereafter
DB) or the so-called defined-contribution pension plan (hereafter DC). In a DB
plan benefits are fixed in advance by the sponsor and contributions are set in order
to maintain the fund in balance. In a DC plan contributions are fixed and benefits
depend on the returns on fund portfolio (of course, also mix structures are allowed in
the real world). DC pension schemes are becoming more and more important in the
pension systems of most industrialised countries and are replacing the DB schemes
that were more frequent in the past. It is well known that the financial risk is mainly
faced by the sponsor in DB schemes and by the member in DC schemes (see, for
instance, Knox 1993).
Contributions and pensions must be linked by a so-called “feasibility” condition
guaranteeing it is convenient for both the pension fund and the member to
underwrite the pension scheme. Such a condition is also present, for instance, in
Sundaresan and Zapatero (1997) and Josa-Fombellida and Rincón-Zapatero (2001).
The latter work, in particular, examines the problem of a firm which must pay
both wages (before its workers retire) and pensions (after they retire). Thus, a
“feasibility” condition implies the equality between the total expected value of

© Springer Nature Switzerland AG 2021 1

F. Menoncin, Risk Management for Pension Funds, EURO Advanced Tutorials
on Operational Research, https://doi.org/10.1007/978-3-030-55528-3_1
2 1 Introduction

wages and pensions paid with the total expected value of worker productivity
(according to the usual economic rule equating the optimal wage with the marginal
product of labour).
The demographic dimension is introduced via a survival probability for the
member of the pension fund whose time of death τ is stochastic. Furthermore, in
order to take into take into account a longevity risk, we also assume that the force
of mortality of τ is stochastic itself (in a so-called double stochastic framework).
Let us remark that the mortality risk supported by a single subscriber is much
more important than the one supported by the fund, and, nevertheless, the longevity
risk cannot be effectively managed through a mutualisation technique. The only
effective tool for hedging against longevity risk is a derivative on human life (like,
for instance, a longevity bond).
Here, we take into account a fully funded pension fund where pensions are paid
using only the contributions paid by each member. This means that we do not take
into account any overlapping generation (see, for instance, Haberman and Sung
1994).
The existing literature dealing with the asset allocation problem for a pension
fund in a mixed actuarial and financial framework, mainly neglects the longevity
risk, while some works deal with the mortality risk (see, for instance, the sem-
inal paper of Richard 1975 and Charupat and Milevsky 2002 and Young and
Zariphopoulou 2002 for a more recent reference).
The optimal investment strategy in the accumulation phase (i.e. prior to retire-
ment) in a DC framework has been derived in the literature with a variety of
both objective functions (mainly maximisation of expected utility of final wealth)
and financial market structures (see, among others, Boulier et al. 2001; Vigna and
Haberman 2001; Haberman and Vigna 2002; Deelstra et al. 2003; Devolder et al.
2003; Battocchio and Menoncin 2004; Xiao et al. 2007; Battocchio et al. 2007; Gao
2008; Di Giacinto et al. 2011).
There is relatively little literature on mean-variance portfolio selection in long-
term investment planning and in pension funds (see also Steinbach 2001). Mean-
variance problems for DC plans are solved in He and Liang (2013), Yao et al. (2013),
Yao et al. (2014), and Vigna (2014); for DB plans they are solved in Josa-Fombellida
and Rincón-Zapatero (2008) and Delong et al. (2008). In continuous time the mean-
variance optimisation problem has been solved for the first time analytically by
Richardson (1989), and then by Bajeux-Besnainou and Portait (1998), both through
the martingale approach. The quadratic utility presents some drawbacks that will be
shown in this work while describing how to represent agent’s preferences.
Despite the relevant and increasing hedging need of pension funds and annuity
providers, the market for longevity risk, i.e. the risk of unexpected changes in the
mortality of a group of individuals, is not sufficiently liquid yet.
Many reasons may have contributed to undermine a rapid development of the
market, such as the lack of standardisation, informational asymmetries, and basis
risk. Nevertheless, recent developments provide a sound technology for modelling
the systematic randomness in mortality (see e.g. Lee and Carter 1992), for designing
1 Introduction 3

and evaluating hedging instruments (Blake et al. 2006 and Denuit et al. 2007) and
for managing longevity risk (Barrieu et al. 2012).
Furthermore, the transfer of longevity risk from pension funds to re-insurers
has become more and more common, although on an over-the-counter basis. For
instance, the volume of outstanding UK longevity swaps has reached 50 billion
pounds as of the end of 2014, with a prevalence of very large deals, such as the 16
billion pounds swap between BT Pension Scheme and Prudential and the 12 billion
Euros Delta Lloyd/RGA Re index-based transaction. Investment banks have been
also actively in the transactions. Between 2008 and 2014, alongside reinsurance
specialists, JP Morgan, Credit Suisse, Goldman Sachs, Deutsche Bank and Société
Générale were involved in longevity deals (Luciano and Regis 2014).
Longevity-linked products should be of interest to asset managers for at least
two reasons: their low correlation to other asset classes (at least in the short run, see
Loeys et al. 2007), and their effectiveness in hedging individual investors against the
unexpected fluctuations of their subjective discount factors, which take into account
lifetime uncertainty (Yaari 1965, Merton 1971, Huang et al. 2012).
The aim of this work is to present and study the optimal portfolio choices of a
pension fund subject to longevity risk during both the APh and the DPh. The fund
can invest in a friction-less, arbitrage free, and complete financial market where both
traditional assets (bonds and stocks) and a longevity bond are listed. We consider a
fixed deterministic retirement age, in contrast with Farhi and Panageas (2007) and
Dybvig and Liu (2010) for instance, who consider an endogenous retirement choice.
An extensive literature has explored consumption and investment decisions when
mortality contingent claims are present. In particular, Huang and Milevsky (2008)
analyse the decisions of families in the presence of income risk and life insurance.
Explicit solutions are also obtained by Pirvu and Zhang (2012) with stochastic asset
prices drifts and inflation risk and by Kwak and Lim (2014) with constant relative
risk aversion (CRRA) preferences. All these papers consider a deterministic force
of mortality, while we model it as a stochastic process. We describe longevity risk
by means of a doubly stochastic process whose intensity follows a continuous-
time diffusion (as in Dahl 2004). This process may be correlated with the other
state variables. With stochastic mortality, both individuals and annuity/life insurance
sellers are exposed to unexpected changes in the force of mortality, implying under
or over reserving.
The optimal investment problem of pension funds in the accumulation phase has
been studied for instance by Battocchio and Menoncin (2004) and Delong et al.
(2008), while Battocchio et al. (2007) propose a unified model for describing both
the APh and the DPh. The role of longevity-linked assets in investor’s optimal
portfolio has been addressed first by Menoncin (2008). Maurer et al. (2013), solving
a life-cycle portfolio investment problem with longevity risk, assess the importance
of variable annuities to smooth consumption, while Horneff et al. (2010) analyse the
role of deferred annuities. They find that these products should optimally account
for 78% of the financial wealth of a retiree.
While insurance products are non-marketable, longevity assets on the market
allow individuals to dynamically hedge against mortality fluctuations (we abstract
4 1 Introduction

from transaction costs). Cocco and Gomes (2012) analyse, in the context of a life-
cycle model, the demand for a perfect hedge against shocks in the life expectancy
of a CRRA agent. They study the optimal investment in a longevity bond, which
is akin to our zero-coupon longevity asset. In their numerical simulations, they find
that individuals—at old ages and especially approaching retirement—should invest
a relevant fraction of their wealth in the longevity asset.
Here, we show how to obtain a closed form solution to the problem of a fund,
under Hyperbolic Absolute Risk Aversion (HARA) preferences, when mortality
intensity is stochastic. We also provide a calibrated application, which allows to
appreciate the relevance of longevity products in the optimal portfolio.

1.1 The Structure of the Book

The aim of this work is to show how to solve the asset allocation problem of a
pension fund which aims to maximise the expected utility of the wealth remaining
at the death time of a representative pensioner. Of course, this framework is akin to
that of a pension fund which works on a cohort of workers.
If we call τ the stochastic death time of a representative pensioner, wt the vector
containing the fund’s portfolio and ρt the rate used by the fund for discounting
future cash flows, the problem of the fund can be written as
 τ 
− ρ ds
max Et0 U (Rτ ) e t0 s ,
wt∈[t0 ,τ ]

where Rτ is the wealth of the fund at the death time, U (•) is the utility function
and Et0 [•] is the expected value operator conditional to the information available at
time t0 . The fund’s wealth dynamics is driven by both the values of the assets held
by the fund in its portfolio and the external cash flows given by the contributions and
the pensions. Finally, the fund must face the risks modelled by many state variables
such as: interest rate risk, mortality and longevity risk (stochastic force of mortality),
inflation risk. In our general framework we will take into account any (finite) number
of state variables, but we will also present some particular cases.
Each element of this optimisation problem is studied in this work according to
the following schedule.
1. The utility function is useful for taking into account the risk aversion that the
pension fund is assumed to inherit from its subscribers (the workers/pensioners).
In the first chapter we show how to interpret the shape of the utility function for
representing investor’s preferences.
2. The second chapter presents the stochastic processes that will be used in the
work in order to model the state variables of the optimisation problem. Some
estimation techniques will be shown too.
1.2 The R Software 5

3. The third chapter shows how a financial market can be modelled through the
stochastic processes presented in the previous chapter. In particular, we show
how to model a portfolio of risky and risk-less asset and how to price assets
through the fundamental theorem of asset pricing in an arbitrage free financial
market. The issue of an incomplete financial market will also be shown.
4. Chapter 4 will show how to use stochastic processes for modelling the actuarial
variables, like the survival probability or the mortality intensity.
5. In Chap. 5 the fundamental theorem of asset pricing will be used in a version
suitable for pricing actuarial assets thought of as derivatives written on the
force of mortality which is a stochastic process itself (modelled in the previous
chapter).
6. The Chap. 6 presents the theoretical computation of the optimal portfolio for a
pension fund by using the so-called “martingale method”. We demonstrate that
this optimal portfolio is formed by a speculative and a hedging component and
their roles and characteristics are described in full details.
7. In Chap. 7 we perform a full numerical example with US data and we show the
values of the optimal portfolio containing a risk-less asset, a stock, a rolling zero
coupon bond, and a rolling longevity zero coupon bond. The dynamics of the
optimal asset shares are shown and commented.
8. The last chapter is devoted to the case of a pure accumulation fund that receives
contributions and pays a final amount of money at retirement, without any
mortality/longevity risk (i.e. all the wealth matured for the contributors is paid to
the heirs in case of death). This case is show just as a benchmark for underlining
in a deeper way how the longevity risk affects the optimal asset allocation of a
pension fund.

1.2 The R Software

In this book we will use the R free software https://www.r-project.org/ and its
free interface RStudio https://www.rstudio.com/. A full introduction to the R
programming language is out of the scope of this book. Here, we just out-
line the main features of R. Other (and similar) software like Matlab (or its
freeware clones like Scilab—https://www.scilab.org—or Octave—https://www.gnu.
org/software/octave/), use mainly a vector/matrix approach to computations, while
R also and mainly works with data frames and lists.
In this work we use the package Knitr for LATEX (http://yihui.name/knitr/) which
allows to code and execute R scripts directly on a LATEX document without using
externally the R software.
In the following code we show how to create three sets of data (with command
c) and show the first one.
6 1 Introduction

The number between brackets is the number of the first element of the row. In
this example, the first element of the first row of A is the element number 1.
All the sets that have been created can be put together into a data frame through
the following commands, where we also show the whole set and a subset of it.
Finally, the mean of the second subset is computed. In order to recall a subset of a
data frame, the dollar symbol is needed. In the following example, the data frame
X contains the subsets A, B, and C which are identified as X$A, X$B, and X$C
respectively.

A matrix can be created by concatenation of the sets A, B and C (row by

row through the command rbind—or column by column through the command
cbind). The new matrix (called M) can be used as argument of a matrix command
like computing its determinant (det) or its transposition (t).
1.2 The R Software 7

When two matrices are multiplied through the command *, the product is applied
element wise. In order to apply the matrix product, we must use the command %*%,
as we can see in the following example.

If the command rbind is used on a matrix and a single number, a new row
is appended to the matrix and all the elements of this row are equal to that single
number.

The elements of a matrix or a set are identified by their coordinates inside

brackets.

A subset of elements can be selected by using brackets, comas, and colon as

follows.
Discovering Diverse Content Through
Random Scribd Documents
he had let go the halyards, bringing the heavy yard, with its bellying
sail, to within a few feet of the deck.
Fortunately Gripwell had the sense to thrust his whole weight upon
the stout tiller to keep the vessel on her course dead before the
wind. In a few minutes the squall had passed.
Descending into the forehatch the Norman lad soon re-appeared,
bearing a small sail rolled up under his arm. This, with Geoffrey's
aid, he bent to the yard, in place of the larger canvas, and under
easy sail the Etoile de St. Valery—for such was the name of the
stolen craft—tore before the howling winds. Ugly, white-crested
waves reared themselves on either hand, but, thanks to her broad
beam and comparative deep draught, the threatening breakers
swept harmlessly under her hull.
"Where are we?" asked Oswald dolefully, for he had succumbed to
the attacks of his old enemy, and was lying well-nigh helpless
against the low bulwarks.
"St. George be my aid: I know not," replied Gripwell. "But by yonder
sun that tells close on midday, I perceive we are holding a proper
course," he added, pointing to a faint light in the fleeting clouds that
marked the position of the orb of day.
For the next hour or two the Etoile de St. Valery flew before the
gale, heading blindly towards the as yet invisible shores of England.
Suddenly Geoffrey gave a warning cry, and pointed his finger
towards the boat's bow.
"I see land," he shouted, striving to make himself heard above the
roaring of the elements.
"Thou'rt right," agreed Gripwell, as an apparently unbroken wall of
glistening chalk cliffs loomed up through the mirk. "But 'twill be a
hard task to get into safety with this sea running. Certes, yesternight
I would have given a seven pound candle to the altar of the church
of St. Thomas à Becket at Warblington to be able to see yon cliffs,
but now I would willingly give one of a score pounds not to see
them."
"How so?" asked Geoffrey.
"Since we know not on what part of the coast we have lighted, and
not a sheltering port is to be seen, methinks we shall have much ado
to prevent our corpses being washed ashore."
"Can we not cast anchor?"
"'Tis impossible, monsieur," replied the Norman lad, who had
overheard Geoffrey's question. "The stout rope that holds the anchor
would be rent asunder like a wisp of smouldering flax. Nay,
monsieur, we must needs push on, keep the boat's stem to the
waves, and trust to be cast fairly on shore. Alas for the Etoile de St.
Valery!"
"Courage, comrades," shouted Gripwell. "I espy a place where the
cliffs dip somewhat. We will run the craft ashore at that point. Pull
thyself together, Master Oswald. E'en within an hour thou mayst set
foot on dry land."
As the Etoile approached the shore the seas became shorter and
steeper owing to the shoaling bottom. No longer did the stout craft
rise easily to the rollers, but labouring heavily she took in water on
all sides.
"There are men on the shore," said Geoffrey, as a number of people
armed with bows, swords and axes, ran down the steep gorge in the
cliffs.
"And a warm welcome they will give us," replied Gripwell gloomily.
"Not a hand will they raise save to help themselves."
The old man-at-arms spoke truly. Every foreign ship—ay, and many a
luckless English craft as well—that had the misfortune to be cast on
shore was regarded by the lawless men of the coastwise hamlets as
a prize. In many cases not only were their crews left to their fate,
but any unfortunate man who reached the shore alive might be
cruelly slain for the sake of a few trifles on his person.
"Hold fast as she strikes!" shouted Gripwell. With feet placed wide
apart and body braced to meet the shock the man-at-arms gripped
the tiller.
Then with a crash that shook the craft from keel to masthead, the
doomed vessel grounded heavily on the shingle.
Thrice she pounded heavily, each time being cast nearer in shore, till
with her hold filled with water, the Etoile settled firmly on a bed of
sand.
Desperately her crew held on, watching the callous spectators on
shore, who, in turn, were waiting for the wreckage to be cast at
their feet. Not a word was spoken by the shipwrecked men; all they
could do was to await the end in whatever form it might come.
After a considerable time had passed in this hazardous position
Geoffrey fancied that the shocks were becoming less violent.
Cascades of foam still swept over the craft, and already portions of
the hull were beginning to show signs of breaking-up. All but the
stump of the mast and the small spread of sail had vanished, having
gone by the board soon after the first shock.
Yes, now he was certain; the tide was falling.
Making his way along the steeply sloping deck to where Arnold was
standing Geoffrey communicated the discovery.
"Ay, it gives us hope," shouted Gripwell in reply. "The boat holds
together. In another half-an-hour we may essay the task."
So saying he whipped out his knife and began to sever one of the
ropes that trailed across the deck. It was a hazardous business,
since he had to release his grasp upon the coaming of the hatchway;
but by dint of working hard between the sweep of each succeeding
breaker he contrived to secure a goodly coil of cordage.
With this the four members of the crew were lashed together with a
distance of about twelve feet between them.
These preparations were observed by those on shore, for there was
a decidedly hostile movement on their part, some going so far as to
string their bows.
"Look at them," exclaimed Jean excitedly. "They are about to kill us."
"And these are Englishmen!" added Oswald.
Hoping to pacify the clamorous throng ashore, the man-at-arms
shouted that he and his comrades were Englishmen, but either the
words were lost in the howling of the wind and the roar of the
breakers, or the shoremen were convinced that since the wrecked
craft was of foreign build the crew must likewise be foreigners. But,
whatever view they took of the situation, the mob showed no signs
of abating their hostility.
At this juncture a horseman appeared on the edge of the cliffs to the
right of the gorge. For a brief space he took in the strange scene
beneath him, then, unhesitatingly, he urged his steed down the
steep declivity. Often the intrepid rider was standing in his stirrups
as the horse slid on its haunches; more than once a mass of chalk
slipped away from under the beast's forefeet and came crashing on
to the beach below; but the daring horseman never ceased his
downward way till he gained the shore and tore up to the crowd of
expectant wreckers.
Although the new-comer was evidently a man of some position he
did not, at first, have things his own way. Voices were raised in
angry protest, twice or thrice knives gleamed in the air, but by sheer
force of will the horseman succeeded in calming the more turbulent
members of the assembly.
This done he forced his horse through the waves, till up to the girths
in water, he came within a spear's length of the stranded craft.
"Throw me yon rope; follow me, your lives are safe!" he shouted.
With that Gripwell heaved the line, and struggling through the
strong under-tow the four members of the crew gained the land.
"Who are ye, and whence came ye?" demanded their rescuer.
"We are Englishmen escaped from France," replied Gripwell.
"There, did I not say so?" asked the horseman turning towards the
still surging crowd. "Fie on ye."
"But the boat is ourn by ancient rights," objected a bearded
fisherman, whose ears were pierced by a pair of gold earrings,
probably part of the spoil from some castaway.
"Let them have the craft by all means," quoth Gripwell. "I' faith, we
are right glad to see the last of her."
"Where were ye making for?" asked the horseman.
"Firstly to the shores of England, which, by St. George, we have
made far too forcibly to my mind. Secondly we belong to the Castle
of Warblington. Yonder stands Geoffrey Lysle, son of the Lord of
Warblington."
"Thou hast gone wide of the mark, good shipmaster," replied the
horseman with a merry laugh. "Now ye must needs foot it for nearly
a score of leagues ere ye reach Warblington. Ye are now at Birling
Gap, midway on the shore of Sussex. Hast money? Nay? Then here
is a groat apiece. Follow yon track and ye'll soon strike the great
highway betwixt Dover and Southampton. The rest of the way,
though it be long, is not difficult to find."
"One moment, fair sir," quoth Geoffrey. "To whom do we owe this
right courteous treatment?"
"It matters not," was the reply, as the horseman prepared to take his
departure. "But stay; if so be that ye have time to remember me in
your prayers, men call me Wild Dick o' Birling."
 CHAPTER XVII

OF THE COMPANY AT THE SIGN OF THE BUCKLE

G lad to have come out of their difficulties so lightly, Arnold Gripwell

and the three lads set out along the path indicated by the kindly
Dick o' Birling.
Reaching the summit of the cliff they turned to gaze upon the scene
of their shipwreck. Far below them the crowd of wreckers and
fishermen seemed like a swarm of ants as they flocked around the
stranded hull of the Etoile, now left high and dry, slashing with their
axes at the planks and tearing away everything they could lay their
hands on.
The sun was low in the western sky ere the wayfarers crossed the
Ouse at Seaford and reached the little village of Bishopstone.
"Here is an inn," said Gripwell, pointing to a long straggling building,
from the upper storey of which a broom was displayed denoting the
fact that wayfarers could find rest and refreshment.
"Welcome to the Buckle Inn, gentles," shouted the host. "What
might be your commands?"
"A joint of English roast beef will not be amiss," replied Gripwell.
"After that beds with fresh straw, an it please thee."
"The Buckle is ever known for the quality of its beds, fair sirs,"
replied the host with well-assumed dignity. "I pray ye enter."
The four wayfarers promptly accepted the invitation, and found
themselves in a long narrow room, with low, oaken rafters black with
smoke. Gathered around a fire blazing on an open hearth were
nearly a score of men, clad in white surcoats blazoned with the cross
of St. George. Many of them had removed their armour, and were
stretching their limbs before the comforting fire.
"Welcome, comrades," shouted a burly giant with a thick crop of
reddish hair. "Sit at your ease and drain a tankard with honest
archers. Whence come ye?"
"From France," replied Gripwell, overjoyed at the sight of a friendly
surcoat.
A roar of laughter greeted his reply.
"From France, quotha? Nay, by my hilt, ye are going the wrong way.
'Tis to France that all stout-hearted men are wending their way."
"Nor will ye find me backward in that matter," replied Arnold stoutly.
"We have but lately set foot in England and are sore in want of
news. Discuss with us, I pray thee."
"Hast not heard that King Harry hath summoned all true Englishmen,
knights, squires, men-at-arms and bowmen to assemble at
Southampton for the taking of France? Such an army hath never
before been equalled. They say that a chirurgeon and twelve others
of his class are to go with us for the comfort of the sick and
wounded."
"The first part of thy speech delights my heart, comrades, but
concerning the latter, one leech in the field will, I trow, do more
harm than a score of French lances."
"Thou speakest pertly, sir stranger. Methinks if thy comb were cut
thy crowing would be somewhat less."
"Give me a stout broadsword, archer, and I'll warrant, old as I am,
that thou wilt not clip it."
This was a direct challenge. In a moment all was confusion, some of
the company shouting encouragement to the man-at-arms, others
urging their comrade to carry out his threat, while the host of the
Buckle besought his patrons to have regard for the good ordering of
the inn.
"The loan of thy sword, friend," said Gripwell calmly, addressing
himself to an archer who was shouting himself hoarse on his behalf.
"Take it comrade—but stay, where have I seen thy face before? Why,
'tis none other than Arnold Gripwell, who clove a Scot to the chin
with his own claymore at Homildon Field."
"Then thou art Thomas Voysey, the archer who threw the ox over his
shoulder in the market-place at York. By St. Thomas à Becket, to
think that I did not recognize an old comrade ere this. Thy hand,
Thomas; when this slight bickering is over I'll quaff a tankard with
thee."
"Nay, I meant no offence," protested the man who had expressed
his intention of cutting Gripwell's comb. "I have ever a regard for a
staunch veteran."
"'Tis too late to climb down, friend," replied Gripwell resolutely. "If so
be that thou art unwilling to cross steel, let us discuss the matter in
another way. I do perceive a bundle of stout staves in yonder corner.
What sayest thou—art willing to try a bout with cudgels?"
Clearly the aggressor was anxious to avoid an encounter, but
yielding to the clamour and ironical jeers of his comrades, he
selected a weapon and stood on his guard.
"Have at thee," shouted the man-at-arms, and the next instant the
bout began.
With a quick succession of dull taps as the cudgels met, both
combatants warmed to their work. Blows were smartly parried and
counter-strokes rapidly delivered. Arnold's antagonist was younger
and more heavily built, but he lacked the endurance and coolness of
the veteran. Slowly, but surely, amid the subdued enthusiasm of the
spectators, the elder man forced his opponent backwards, till, with
the sweat running down his face and his breath coming in quick
gasps, the archer lost all control of himself. Whirling his heavy
cudgel he strove by a succession of powerful strokes to break down
the veteran's guard; till, seizing a favourable opportunity, Gripwell
got home a shrewd blow on his antagonist's forehead, following it up
by a sharp cut that sent the archer's weapon flying to the far end of
the room.
"Thou art the better man," gasped the archer, clapping his hands to
his bruised pate.
"Spoken like a sensible rogue," replied Arnold, throwing down his
cudgel. "My hand, comrade! Thou, too, shalt share a cup with me,
though I have but a groat in my pouch, of which one penny is for
my bed. Host, a tankard of thy best ale."
Good humour having been restored, the rest of the evening passed
in story and song, till tired out with the crowded events of the last
few days, Geoffrey and his companions were glad to seek repose.
On the morrow it was decided that the man-at-arms and his
comrades should travel in company with the archers, not only for the
sake of protection on the road, but because the sturdy and honest
soldiery, hearing the condition of Geoffrey and Oswald, insisted on
sharing their meals with the lads who had undergone such
adventurous ordeals in the land of the Fleur de Lys.
"I cannot see why King Harry—God bless him!—should call his army
together at Southampton," remarked Voysey, the master-bowman,
as the company took to the road once more. "I am a man of Rye,
my comrades all hail from ancient and loyal Cinque Ports, and seeing
the distance across the Channel is lesser than from Southampton, it
is passing strange that we should have this long march thither, not
that I complain—'tis a soldier's duty to obey orders."
"Nevertheless, to me the plan is simple enough," replied Gripwell.
"By landing at Harfleur—a strong place, for I know it well—and
advancing up the valley of the Seine the King can use his army as a
wedge, to split the French kingdom asunder. Rouen and Paris, rich
cities, are likely to fall into his hands, and, mark you, the booty that
is to be had!"
"Ay," replied the bowman, reflectively. "A man can cross to France
with naught but his clothes and his arms, and return home laden
with gold. 'Twas thus in my grandsire's time. So now for a
prosperous campaign, comrades!"
Talking thus, the long miles seemed to slip by, and late afternoon
found Geoffrey and his comrades in the city of Chichester.
"'Tis enough for one day," observed the leader of the detachment of
the Cinque Ports archers. "Here we will rest till the morrow."
"As thou wilt," replied Gripwell. "But since we are within half a score
miles of Warblington, my young masters will be wanting to push on.
How sayest thou, Master Geoffrey?"
"Right gladly, Arnold."
"Then so be it. Comrades, adieu, and may we meet ere long on
French soil."
Amidst the boisterous and hearty farewells of the archers Geoffrey
and his three companions set out on the last stage of their
homeward journey. Along the well-known highway they sped,
recognizing in every landmark an old friend. Quickly the great West
Gate of Chichester was left behind; then the Saxon tower of Bosham
Church loomed up on their left hand, to bear them company till the
fishing hamlet of Emsworth hove in sight. Then, joy of joys, the grey
tower of Warblington Castle, standing out clearly against the setting
sun, bade them welcome home.
As for Geoffrey, the discomforts and perils of his journeyings were
forgotten; he regarded them as a closed page of his life-story. He
realized that a new phase of his existence was about to commence,
and that on French soil he would have a chance to win his spurs. But
even in the midst of his day-dreams came the disquieting thought
that, however creditably he had borne himself in his mission, he had
left Sir Oliver still a prisoner in a foreign land.
 CHAPTER XVIII

SQUIRE GEOFFREY

"W elcome, Geoffrey. I bring thee good tidings," exclaimed

Oswald, slipping from his saddle and embracing his friend
and tried comrade.
It was a month after Geoffrey's home-coming, but during that period
much had taken place.
The Lady Bertha had warmly welcomed her son, whom she had
almost given up as lost. Concerning Sir Oliver her anxieties were
greatly relieved, since she now knew that he had effected his escape
from the clutches of the Lord of Malevereux. Sir Raoul d'Aulx, her
husband's captor, she also realized to be an upright and gentle
knight, in whose hands Sir Oliver would be sure of honourable
treatment. The loss of Taillemartel she regarded with equanimity,
since the fief was ever a source of anxiety and trouble.
"Taking all things into account, Geoffrey," said the châtelaine, "I
have much to be thankful for. Next to thy father's life his liberty is
most to be desired, but for the nonce I must rest content. But,
another matter: since it is our noble King's pleasure to lead an army
into France, it is the duty of his loyal subjects to make sacrifices to
that end. Had thy father been here he would gladly have placed
himself at the head of his retainers and led them to the rendezvous
at Southampton. Since that is impossible, and that our men and
archers must go nevertheless, 'tis fitting that, as thy father's heir,
thou should'st lead them. Now, art willing to do so? Remember,
unless thy heart be in thy work 'tis labour in vain."
"Madame, such is my ardent desire," replied Geoffrey, his eyes
sparkling with enthusiasm.
"I expected no other answer, my son. Go, and may the saints protect
thee. Of the nineteen men-at-arms, fifteen are to join the King's
army; of the thirty and seven archers I purpose keeping but five.
Thus the quota provided by the Manor of Warblington will number
forty-seven men under Oswald and thyself, too few to form an
independent company. Therefore I have asked Sir Thomas Carberry
to allow our men to muster under his banner. If he be willing—and I
have no doubt to the contrary—his reply will be forthcoming ere
night, for Oswald hath ridden over to Portchester this morn."
"I crave thy patience on a small yet weighty matter, mother,"
exclaimed Geoffrey. "What is thy wish concerning Jean?"
"The Norman fisher-lad whom thou hast brought overseas? 'Twould
be unseemly to send him back to France with thee. I have already
spoken to the lad, and, by St. George, he is no patriot. Doubtless he
finds himself well treated here, for with tears in his eyes he
besought me to keep him here at Warblington. Therefore 'tis my
purpose to place him under the charge of Herbert the falconer, since
for a Norman peasant lad he showeth great promise."
"On that score, then, my mind is easy," replied Geoffrey. "And now
tell me, when do we set out for Southampton?"
"The King's orders are that the troops assemble on the Feast of St.
Christopher, the twenty-sixth day of the present month. That is but
four days off, and it would ill-become the retainers of Sir Oliver were
they not the foremost of the fore, since the men of Hampshire are
ever amongst the first to obey the call to arms. Therefore, by the
day after to-morrow thou must bid me farewell."
It was at this juncture that Oswald Steyning came to Warblington
with the words, "Welcome, Geoffrey. I bring thee good tidings."
"Ay, Oswald, I have already heard the news. I am to serve my lord
the King in the field."
"Then thou hast but heard a moiety. Sir Thomas Carberry sends
greeting to the Lady Bertha, and expresses his regard for the
courtesy of the Châtelaine of Warblington in entrusting her
contingent to his care. Moreover, he offers thee, Geoffrey, the post
of second squire to attend upon his person."
"Good news! Good news indeed!" exclaimed Geoffrey. "Thou and I,
then, are to be fellow squires as well as companions in arms."
"Save that I am a masterless squire," added Oswald. "I would that
Sir Oliver displayed his banner side by side with the crescent and
star of Sir Thomas Carberry."
"And Richard Ratclyffe—what of him?"
"He is first squire to Sir Thomas, and will, of a surety, attend on him.
But I saw him not, since he hath already journeyed to Southampton
to see to the ordering of the Portchester company's camp."
During the remainder of the day, and the day following as well,
activity reigned within the walls of Warblington. Though every man
had been well equipped, much had to be done ere the little band set
out to throw in its lot with the men of Portchester. Horses had to be
re-shod, swords, bills, and spearheads required grinding and
sharpening, bows had to be overhauled, spare cords waxed, and
barrels of arrows prepared. With the men-at-arms and archers
twelve sumpter horses with their attendants were to bear the
baggage as far as the camp of Southampton, while, by express
orders from the King, smiths were at work day and night preparing
iron tips for the stakes that were to play so important a part in the
forthcoming campaign.
At length the time of departure drew near. Having bade farewell to
his mother, the châtelaine, Geoffrey, now accoutred cap-à-pied in
bascinet, globular breastplate, steel gorget, greaves and sollerets,
took his place at the head of the column, with Oswald, similarly
attired, at his right hand.
A spear's length in the rear rode Arnold Gripwell with a grim look of
expectancy on his rugged features, as he bore the banner of the
turbot and the three stars of Warblington. A close observer would
have noticed a wavy black line running athwart the banner from
corner to corner, signifying that the knight whose device it was was
absent or prevented from taking personal command.
Behind Gripwell rode the fourteen men-at-arms, wearing steel caps
and quilted coats, additionally protected by iron plates, while at the
side of each hung a two-handled heavy-bladed sword.
The archers were on foot, each man clad in leather jacket, over
which was a white surcoat with the cross of St. George, loose hose,
and caps of either stiff leather or wicker-work stiffened with bars of
iron. They were armed with the world-renowned bows of English
yew, a well-filled quiver of arrows hanging from the right-hand side
of their belts, while as a supplementary weapon every man carried a
short axe or a dagger.
In the rear were the sumpter horses and baggage, attended by a
number of the tenantry of Warblington, who were to accompany the
troops only as far as the port of embarkation.
The first day's march was an easy one. That night the men of
Warblington joined those of Portchester, and quickly the two
companies fraternized, since they had much in common and little
cause for dissension.
As the combined forces were about to leave the Castle of
Portchester, Sir Thomas Carberry turned to his newly-appointed
squire.
"It is in my mind," quoth he, "that I should bestow upon the Prior of
Southampton this purse of gold for the entertainment of the poor
and needy during our absence overseas. Therefore I pray thee take
Oswald and ride across the hill to Southwick. Thou knowest the
Priory?"
"I have heard of it only, sir."
"'Tis easy to find, though the road thither be rough. Present my
compliments to the worthy Prior and give him this. Thence thou
canst make thy way through the villages of Wickham and Botley and
rejoin us at the camp at Bitterne, hard by the town of Southampton.
Have I made mine orders clear?"
"Yea, Sir Thomas."
"Then set forth directly the troops have heard mass. Perchance I
shall not see thee again until thou comest to Southampton, but
these instructions are complete. Pass the word for the men to fall
into their ranks."
A trumpet sounded loud and shrill, and ere its long-drawn note had
died away the eager soldiers were pouring from their quarters into
the outer bailey. Then, to the accompaniment of a series of hoarse
orders shouted by their under-officers, the men ranged themselves
in close ranks.
"Passably done," commented Sir Thomas, as, accompanied by his
squires, he walked towards the centre of the column, where his
standard was proudly displayed. "There was slight confusion in the
ordering of the lines, but I'll warrant another fortnight will amend
all."
It was indeed a force that any knight of Christendom might well be
proud of. Two hundred and forty men, the flower of the yeomen of
South Hamptonshire, were drawn up, armed and accoutred for
active service.
Some of these were old veterans, skilled in the craft of war, gaunt,
sinewy, and stolidly alert; others were middle-aged men, trained by
constant practice at the butts in the use of the deadly long-bow;
while the majority were lads upon whose unwrinkled faces the down
of manhood was beginning to assert itself.
Beyond an occasional brawl, few of the latter had seen a blow struck
in deadly earnest, though they were eager for a chance of winning
fame against the hereditary enemy of England. Their lack of
experience on the field of battle was all but counterbalanced by their
enthusiasm, while the stiffening of veterans was calculated to have a
good effect upon the morale of the comparatively undisciplined
archers of the company.
Having walked between the lines and carefully inspected the men
under his command, the Constable of Portchester addressed them in
a few rousing words. Then, as the prolonged cheering died away, a
tucket sounded, and every man, laying his bow, axe, or sword upon
the greensward, marched slowly and soberly into the church of St.
Mary, that lies within the castle walls.
Half an hour later the rear of the long column had trailed beneath
the land-port tower on its way to the wars, while Geoffrey and
Oswald were breasting the steep ascent of Portsdown that lay
betwixt the Castle of Portchester and the Priory of Southampton.
 CHAPTER XIX

TREASON

H aving carried out the Constable's instructions relating to the Prior

of Southwick, Geoffrey and Oswald set out on their long ride to
rejoin their comrades at Southampton.
Both lads were lightly accoutred, their armour having been sent on
with the baggage train, and in high spirits they cantered their steeds
along the stretch of grass that bordered the narrow highway.
Presently the open country gave place to dense masses of trees, the
outlying confines of the Forest of Bere—the hunting-ground of kings,
and the haunt of robbers and other evil-doers to boot. Yet there was
little fear of wayfarers being molested in this part of the forest, the
outlaws devoting their attentions to the more remote districts, where
the power of the law, as exercised by the Constable of Portchester,
lost somewhat of its terrors. Nevertheless, the two squires rode
warily, keeping a bright look-out for a possible ambush.
"Methinks I hear men's voices," remarked Oswald, reining in his
steed and listening intently.
"And what of it?" replied Geoffrey with a laugh. "Is not the road free
to all, and may not a man talk if so he listeth?"
"Nay, but 'tis like the shout of a multitude."
"I can now hear it, though 'tis a long way off."
"We must needs ride yarely, for it seemeth as if the sound comes
from the highway in front of us. Let us therefore turn aside through
this thicket."
"Nay," replied Geoffrey stoutly. "That shall not turn us from the
highway. Should there be a band of robbers, 'twill be better to keep
to the road than be entangled in the thickets. Let us set spur,
therefore, and put a brave face on't, though truly I doubt that there
be danger."
Thus encouraged, Oswald increased his pace, and, keeping side by
side, the two comrades drew near to the cause of the shouting.
It was a strange sight that met the gaze of the squires, as they
turned a slight bend in the road.
On the right of the highway lay a broad sunlit glade. Seated in a
semi-circle were about two score men, some of whom were yeomen
and farmers, though most were peasants and wood-cutters.
Although many furtive glances were cast in the direction of the
highway, the main attention of the assembly was centred on the
form of a speaker, whom the lads instantly recognized.
"Certes, 'tis my Lord Cobham!" exclaimed Geoffrey. "We have fallen
upon a nest of Lollards."
At that instant one of the assembly happened to catch sight of the
two horsemen, and, giving a warning shout, brought all the crowd to
their feet. Some made towards the undergrowth like startled hares,
but for the most part the Lollards rallied round their leader.
"They will do us no scath," observed Oswald. "Let us therefore ride
past them in peace. Yet 'tis passing strange that these, forming an
unlawful assembly, should fail to set outposts. Had we been a troop
of lances bent on their capture not a man would have escaped."
The squire's resolve to pass them by was doomed to failure, for,
seeing that they were but two wayfarers, several of the men
intercepted them.
"Who are ye, and whence come ye?" demanded a burly miller, his
garments dusty with the traces of his calling.
"Peaceable subjects of King Harry," replied Geoffrey boldly. "Ye are, I
perceive, of the following known as Lollards."
"I trust that ye do not mean to betray us? Otherwise——"
"Nay, threaten us not. We would have speech with Sir John
Oldcastle."
Blank astonishment was written on the faces of the men who had
barred the lads' way. Several of them muttered under their breath
that they were lost men.
"So be it," replied the spokesman briefly, and laying hold of the
bridle of Geoffrey's horse, led him to where Lord Cobham was still
standing, surrounded by the braver of his followers.
"Greetings, my Lord Cobham," exclaimed Geoffrey, raising his velvet
cap, to which salutation Sir John Oldcastle courteously replied. "I
pray thee that thy men give us free passage."
"Who art thou, fair sir?" asked the knight.
"Canst call to mind the time thou rebukedst the friar hard by the
Castle of Portchester, my lord?"
"Nay, is it possible that thou art the lad who stood by?" asked
Oldcastle. "Thou hast grown somewhat, I trow."
"Tis the same; and my companion here was also with me on that
day. In truth, sir knight, though I be a true member of the Church,
thy action I could not but admire."
"My work in that direction still remains unfinished," remarked Lord
Cobham. "Behold me, a fugitive, thanks to the persecution of my
Lord Archbishop. The meanest of these my followers might be the
richer by the sum of a thousand marks were they to betray me; but
on that score I have scant anxiety. My destiny is in the hands of One
above, and should it please Him to hand me over to mine enemies,
His will be done."
"Ask them to swear secrecy concerning thee, fair lord," said one of
the Lollards.
"Nay, I ask no pledge; their way is clear."
"Friends," exclaimed Geoffrey, "I tell ye this: concerning this meeting
we two will keep our own counsel. Nevertheless, if the question is
put straightly to us in this matter we must reply truthfully."
"Bravely spoken, young sir," replied Oldcastle. "It will suffice me,
though I trust none will ask thee if thou hast seen aught of me and
my following. Now farewell, and the blessing of Heaven be with ye
both."
Geoffrey was fated never to see the great Lollard leader again. It
was not, however, till two years later, in 1417, that Oldcastle was
captured in the fastnesses of Wales after a desperate resistance.
Hailed to London, he was brought to trial, and even his former
friendship with the King could not save him from the vindictiveness
of the ecclesiastical party, for, under circumstances of extreme
barbarity, he suffered death by fire.
For the next five or six miles the lads conversed on the incident they
had just witnessed. The road was practically deserted, and beyond
the sight of a peasant walking in the fields, or a chapman ambling
along with his wares, the two squires saw nothing to attract their
attention.
Late in the afternoon they arrived at the village of Botley, where the
horses had to be fed and watered. While the beasts were being
attended to the clatter of horses' hoofs was heard, and swinging
round a bend in the road came about a score of mounted men-at-
arms, all completely equipped, while at their head rode a young man
with a set, grave expression on his thin yet clear-cut features.
"Greetings, fair sirs," exclaimed their leader courteously. "Canst tell
me whether accommodation is to be had for me and mine? We are
bound for Southampton to join the King's army, but having travelled
far this day, 'tis impossible to reach the town this night."
"We also are strangers," replied Geoffrey. "And we, too, are for
Southampton on a like errand as thyself."
"My name is Olandyne, of Ripley, in the county of Surrey. Perchance,
young sirs, ye will bear us company on the morrow?"
"Nay," answered Geoffrey, after he had announced the names and
qualities of Oswald and himself. "We must needs meet my master,
Sir Thomas Carberry, this day. Yet I trust we may meet again on
French soil, even if not before at Southampton."
While the horses were being watered the two squires held
conversation with Olandyne, who had, at his own expense, raised a
troop of a score of men-at-arms for service with the King's forces. At
length, the men-at-arms having found quarters in the village,
Geoffrey and Oswald resumed their way.
Hardly had they gained the hamlet of Hedge End than the sky
became overcast, and a dark, leaden-coloured cloud began to drive
rapidly against the light westerly wind. Then, Nature's sure warning,
the air became sultry and motionless, while even the birds ceased
singing in anticipation of the coming storm.
"'Twill thunder ere long," said Oswald. "Ought we not to find shelter
in one of these cottages? Our velvet cloaks are but a bad protection
from the weather, and 'twould not do to appear before Sir Thomas
like two bedraggled varlets."
"It is my mind to push on," replied Geoffrey. "Perchance we may
escape the storm. See yon cloud bids fair to pass behind us."
"Then as thou wilt, but it behoves us not to spare spur," replied his
companion, urging his horse into a sharp trot.
On and on they rode, Oswald casting anxious glances at the
approaching cloud, while ever and anon the low rumbling of distant
thunder was borne to their ears. Then a few heavy drops began to
fall.
"Thou art right; we are fairly caught," exclaimed Geoffrey. "Were we
campaigning in France 'twould matter but little, but since we may
have to attend the Constable when he is received in audience by the
King, it behoves us to take care of our apparel. I see a cottage
yonder; can we but gain it all will be well."
As he spoke Oswald's horse tripped on a mole-hill, and with a crash
its rider fell to the earth. Fortunately, the soil was soft, and with
nothing more than a shaking the young squire rose to his feet.
"Art hurt?" asked Geoffrey anxiously, as he leapt from his saddle.
"'Tis naught; but alas! my horse."
Oswald's exclamation called his companion's attention to the animal.
The fall had broken one of its fore-legs, but without as much as a
whinny the poor beast stood motionless. Instinct seemed to tell it
that its days of usefulness were numbered.
Having removed the saddle and muffled the horse's eyes, Oswald
drew his dagger, and with a swift blow put the animal out of its
misery.
"Poor Firebrand!" he exclaimed. "'Tis a sorry ending. But let us
hasten, Geoffrey; the rain increaseth."
Together the lads made their way towards the distant cottage,
Geoffrey leading his horse, while Oswald bore the trappings and
saddlery of his dead steed.
Suddenly a vivid flash of lightning seemed to dart across their path,
temporarily blinding them with its intensity. Geoffrey's horse, already
rendered strangely unquiet by the tragedy which had overtaken its
companion, became mad with terror, and, rearing on its hind legs,
wrenched the bridle from its master's hand. Then, snorting wildly,
the powerful brute galloped madly away, leaving the two astonished
squires gazing after it in bitter dismay.
"By the Rood of Bosham, we are undone!" exclaimed Oswald when
he had recovered his speech.
"We shall be utterly so if we tarry here," replied Geoffrey, as another
vivid flash played upon the rain-sodden ground. "Let us run to
yonder hovel."
"And be soaked to the skin ere we gain it? Nay, let us rather take
shelter under that oak," said Oswald, pointing to a large tree that
stood in a slight depression in the ground, half a bow-shot away on
their left.
The squires, ignorant of the danger they were incurring, made their
way to the spot indicated. Here for a while they remained under the
shelter of the thick foliage while the torrential rain descended with
terrible force.
Ere long, though the tree afforded protection from the falling rain,
the surface water began to collect in the hollow surrounding the
base of the gnarled trunk.
"Unless we want to be ankle deep in water we must climb into the
branches," said Geoffrey. "So up with thee, and I'll throw up the
saddle."
With little difficulty Oswald obtained a secure perch on one of the
massive limbs of the oak, and having, after one or two ineffectual
attempts, succeeded in placing the saddle in his companion's hands,
Geoffrey made haste to follow. Here, fairly well sheltered from the
wind and rain, the two squires waited and watched the vivid flashes
of lightning, to the accompaniment of deafening peals of thunder.
For over half an hour the storm lasted, but just as its fury was
beginning to abate Oswald called Geoffrey's attention to a horseman
approaching their place of refuge. He was completely cloaked, while
his broad-brimmed hat was drawn well over his eyes; but since he
rode cautiously and without undue haste 'twas apparent that his
object was not to shelter from the storm.
"Say not a word to him," cautioned Geoffrey. "Methinks the tree is a
trysting-place."
As the stranger came within the protection of the wide-spreading
branches he halted at the edge of the newly-formed pool, secured
his steed, and looked long and steadily in the direction of the tree-
clad valley towards Winchester. As he did so the squires saw that the
lower part of his face was that of a young man and far from