Optimal Long-Term Allocation with Pension Fund Liabilities

Eric Jondeau and Michael Rockinger ()

No 14-58, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We build a macroeconomic model for Switzerland, the Euro Area, and the USA that drives the dynamics of several asset classes and the liabilities of a representative Swiss (defined-contribution) pension fund. This encompassing approach allows us to generate correlations between returns on assets and liabilities. We calibrate the economy using quarterly data between 1985:Q1 and 2013:Q2. Using a certainty equivalent approach, we demonstrate that a liabilities hedging portfolio outperforms an assets-only strategy by between 5% and 15% per year. The main reason for such a large improvement is that the optimal assets-only portfolio is typically long in cash, whereas hedging liabilities require the pension fund to be short in cash. It follows that imposing positivity restrictions in the construction of the portfolio also results in a large cost, between 4% and 8% per year. This estimate suggests that allowing pension funds to hedge their liabilities through borrowing cash and investing in a diversified bond portfolio helps to enhance the global portfolio return.

Keywords: Asset Liability Management; Defined Contributions; Surplus maximization (search for similar items in EconPapers)
JEL-codes: C53 E43 G23 G28 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2014-10
New Economics Papers: this item is included in nep-age and nep-mac
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1458

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