Skip to main content
Log in

Asset-liability management for pension funds in a time-varying volatility environment

  • Original Article
  • Published:
Journal of Asset Management Aims and scope Submit manuscript

Abstract

In this article, we develop a framework for asset-liability management for pension funds in a time-varying volatility environment. We use sophisticated dynamic econometric models for the variances–covariances of the asset classes in which the pension fund is investing, while for the liability structure we employ two standard approaches that have been used in the relevant actuarial literature. The models implemented are used in the asset allocation process of the pension fund, as well as for risk management purposes. The constructed portfolios have significant economic value according to well-known performance measures.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Figure 1

Similar content being viewed by others

Notes

  1. Formerly known as Salomon Brothers Pension Liability Index, available on the website of Society of Actuaries, www.soa.org.

  2. Details about the use of downside risk measures in pension funding can be found in Haberman et al (2003).

  3. The functional we use is the mean of the previous 12 monthly returns.

  4. Data are from Bloomberg Professional Services.

  5. Details can be found in Hedge Fund Research, www.hedgefundresearch.com.

  6. Hedge fund returns can look better than they actually are, because of the empirical biases of the hedge fund databases that are used to construct the relevant indices. Some of the most common biases that arise are the self-selection bias and the survivor bias. Self-selection arises because funds voluntarily report their information to data vendors and may decide to stop doing so. Survivor bias occurs if the hedge funds database, and thus the index employed contains information only on ‘surviving’ funds, that is, funds that continue to operate and report information to the database vendor. Pension fund managers should keep these points in mind during the asset allocation process.

References

  • Alexander, C. (ed.) (2001) Orthogonal GARCH. In: Mastering Risk Volume 2. Harlow: Financial Times-Prentice Hall, pp. 21–38.

    Google Scholar 

  • Alexander, C. and Dimitriu, A. (2004) The art of investing in hedge funds: Fund selection and optimal allocation. In: B. Schachter (ed.) Intelligent Hedge Fund Investing. London: RiskBooks.

    Google Scholar 

  • Amenc, N. and Martellini, L. (2002) Portfolio optimization and hedge fund style allocation decisions. Journal of Alternative Investments 5 (2): 7–20.

    Article  Google Scholar 

  • Amenc, N., Martellini, L. and Ziemann, V. (2007) Asset-liability Management Decisions in Private Banking. EDHEC Risk and Asset Management Research Centre Publication.

  • Bader, L. and Ma, Y.Y. (1995) The Salomon Brothers Pension Discount Curve and the Salomon Brothers Pension Liability Index. New York: Salomon Brothers.

    Google Scholar 

  • Berkelaar, A. and Kouwenberg, R. (2010) A liability-relative drawdown approach to pension asset liability management. Journal of Asset Management 11 (2–3): 194–217.

    Article  Google Scholar 

  • Blake, D. (1998) Pension schemes as options on pension fund assets: Implications for pension fund management. Insurance: Mathematics and Economics 23 (3): 263–86.

    Google Scholar 

  • Bogentoft, E., Romeijn, H.E. and Uryasev, S. (2001) Asset/liability management for pension funds using CVaR constraints. The Journal of Risk Finance 3 (1): 51–71.

    Article  Google Scholar 

  • Bollerslev, T. (1986) Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics 31 (3): 307–327.

    Article  Google Scholar 

  • Bollerslev, T. (1990) Modelling the coherence in short-run nominal exchange rates: A multivariate generalized ARCH model. The Review of Economics and Statistics 72 (3): 498–505.

    Article  Google Scholar 

  • Bollerslev, T., Chou, R.Y. and Kroner, K.F. (1992) ARCH modeling in finance – A review of the theory and empirical evidence. Journal of Econometrics 52 (1–2): 5–59.

    Article  Google Scholar 

  • Boyle, P. and Liew, S.S. (2007) Asset allocation with hedge funds on the menu. North American Actuarial Journal 11 (4): 1–22.

    Article  Google Scholar 

  • Cairns, A.J.G. and Parker, G. (1997) Stochastic pension fund modelling. Insurance: Mathematics and Economics 21 (1): 43–79.

    Google Scholar 

  • Cairns, A.J.G., Blake, D. and Dowd, K. (2006) Stochastic lifestyling: Optimal dynamic asset allocation for defined contribution pension plans. Journal of Economic Dynamics and Control 30 (5): 843–877.

    Article  Google Scholar 

  • Campbell, J.Y. and Viceira, L.M. (2002) Strategic Asset Allocation: Portfolio Choice for Long-Term Investors. Oxford, Oxford University Press.

    Book  Google Scholar 

  • Chiu, M. and Li, D. (2006) Asset and liability management under a continuous-time mean-variance optimization framework. Insurance: Mathematics and Economics 39 (3): 330–355.

    Google Scholar 

  • Engle, R.F. (2002) Dynamic conditional correlation – A simple class of multivariate GARCH models. Journal of Business and Economics Statistics 20 (3): 339–350.

    Article  Google Scholar 

  • Engle, R.F. and Sheppard, K. (2001) Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH. San Diego, CA: University of California. Working Paper no. 2001-15.

  • Erhardt, J., Wadia, Z. and Perry, A. (2013) Milliman Pension Funding Study.

  • Giamouridis, D. and Vrontos, I.D. (2007) Hedge fund portfolio construction: A comparison of static and dynamic approaches. Journal of Banking and Finance 31 (1): 199–217.

    Article  Google Scholar 

  • Haberman, S., Khorasanee, M.Z., Ngwira, B. and Wright, I.D. (2003) Risk measurement and management of defined benefit pension schemes: A stochastic approach. IMA Journal of Management Mathematics 14 (2): 111–128.

    Article  Google Scholar 

  • Hoevenaars, R.P., Molenaar, R.D., Schotman, P.C. and Steenkamp, T.B. (2008) Strategic asset allocation with liabilities: Beyond stocks and bonds. Journal of Economic Dynamics & Control 32 (9): 2939–2970.

    Article  Google Scholar 

  • Kell, A. and Muller, H. (1995) Efficient portfolios in the asset liability context. Astin Bulletin 25 (1): 33–48.

    Article  Google Scholar 

  • Krokhmal, P., Uryasev, S. and Zrazhevsky, G. (2002) Risk management for hedge fund portfolios: A comparative analysis of linear portfolio rebalancing strategies. Journal of Alternative Investments 5 (1): 10–29.

    Article  Google Scholar 

  • Leibowitz, M.L., Bader, L.N. and Kogelman, S. (1996) Return Target and Shortfall Risk, Studies in Strategic Asset Allocation. Chicago: Irwin Professional Publishing.

    Google Scholar 

  • Leippold, M., Trojani, F. and Vanini, P. (2004) A geometric approach to multiperiod mean variance optimization of assets and liabilities. Journal of Economic Dynamics & Control 28 (6): 1079–1113.

    Article  Google Scholar 

  • Markowitz, H. (1952) Portfolio selection. Journal of Finance 7 (1): 77–91.

    Google Scholar 

  • Martellini, L. and Ziemann, V. (2005) The Benefits of Hedge Funds in Asset Liability Management. EDHEC Risk and Asset Management Research Centre Publication.

  • The National Association of Pension Funds (2013) Trends in Defined Benefit Asset Allocation.

  • Papi, M. and Sbaraglia, S. (2006) Optimal asset-liability management with constraints: A dynamic programming approach. Applied Mathematics and Computation 173 (1): 306–349.

    Article  Google Scholar 

  • Rockafellar, R.T. and Uryasev, S. (2000) Optimization of conditional value-at-risk. Journal of Risk 2 (3): 21–41.

    Article  Google Scholar 

  • Rockafellar, R.T. and Uryasev, S. (2002) Conditional value-at-risk for general loss distributions. Journal of Banking and Finance 26 (7): 1443–1471.

    Article  Google Scholar 

  • Sharpe, W.F. and Tint, L.G. (1990) Liabilities – A new approach. Journal of Portfolio Management 16 (2): 5–10.

    Article  Google Scholar 

  • Shiu, E.S.W. (1990) On Redington’s theory of immunization. Insurance: Mathematics and Economics 9 (2–3): 171–175.

    Google Scholar 

  • Smith, A. (2006) Value and risk sharing in defined benefit pension plans. In: N. Kortleve, T. Nijman and E. Ponds (eds.) Fair Value and Pension Fund Management. Oxford, UK: Elsevier.

    Google Scholar 

  • Vrontos, I.D., Dellaportas, P. and Politis, D.N. (2003) A full-factor multivariate GARCH model. Econometrics Journal 6 (2): 312–334.

    Article  Google Scholar 

  • Winklevoss, H.E. (1982) Plasm: Pension liability and asset simulation model. Journal of Finance 37 (2): 585–594.

    Article  Google Scholar 

  • Ziemba, W.T. and Mulvey, J.M. (1998) Worldwide Asset and Liability Modeling. Cambridge, UK: Cambridge University Press.

    Google Scholar 

  • Zhao, Y. and Ziemba, W. (2000) A dynamic asset allocation model with downside risk control. The Journal of Risk 3 (1): 91–113.

    Article  Google Scholar 

  • Zhou, X.Y. and Li, D. (2000) Continuous-time mean-variance portfolio selection: A stochastic LQ framework. Applied Mathematics and Optimization 42 (1): 19–33.

    Article  Google Scholar 

Download references

Acknowledgements

The authors would like to acknowledge financial support from the Committee on Knowledge Extension Research’s (CKER) of the Society of Actuaries (SOA). Furthermore the authors would like to thank Citi Research for providing the Citigroup Pension Liability Index used. The usual disclaimer applies.

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Spyridon D Vrontos.

Additional information

1received his PhD degree in Statistics from Athens University of Economics and Business, Greece, in 2005. Currently he is Senior Lecturer in Finance at the department of Accounting, Finance and Governance, Westminster Business School, University of Westminster, London, UK and on academic leave from Department of Statistics and Insurance Science, University of Piraeus, Piraeus, Greece. His principal research is concerned with asset-liability management, predictability of financial and macroeconomic time series, actuarial and financial modeling, performance evaluation of fund managers and stochastic analysis with applications in insurance and finance.

2received his PhD degree in Statistics from Athens University of Economics and Business, Greece, in 2001. Currently, he is Assistant Professor at the department of Statistics, Athens University of Economics and Business. His main research interests include financial econometrics, optimal asset portfolio allocation, Bayesian inference and Bayesian model choice, time series modeling and analysis.

3received her PhD degree in Statistics from Lancaster University, UK, in 2005. She is currently Lecturer of Statistics at the department of Mathematics, University of Athens, Greece. Her research interests include Bayesian inference and model comparison, computational statistics, filtering methods and Markov chain Monte Carlo methods, econometrics and financial econometrics.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Vrontos, S., Vrontos, I. & Meligkotsidou, L. Asset-liability management for pension funds in a time-varying volatility environment. J Asset Manag 14, 306–333 (2013). https://doi.org/10.1057/jam.2013.24

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jam.2013.24

Keywords

Navigation