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Liability Driven Investment with Downside Risk

29 Pages Posted: 17 Jan 2013  

Andrew Ang

BlackRock, Inc

Bingxu Chen

Columbia Business School - Finance and Economics

Suresh M. Sundaresan

Columbia Business School - Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 16, 2012

Abstract

We develop a liability driven investment framework that incorporates downside risk penalties for not meeting liabilities. The shortfall between the asset and liabilities can be valued as an option which swaps the value of the endogenously determined optimal portfolio for the value of the liabilities. The optimal portfolio selection exhibits endogenous risk aversion and as the funding ratio deviates from the fully funded case in both directions, effective risk aversion decreases. When funding is low, the manager 'swings for the fences' to take on risk, betting on the chance that liabilities can be covered. Over-funded plans also can afford to take on more risk as liabilities are already well covered and so invest aggressively in risky securities.

JEL Classification: -

Suggested Citation

Ang, Andrew and Chen, Bingxu and Sundaresan, Suresh M., Liability Driven Investment with Downside Risk (October 16, 2012). Netspar Discussion Paper No. 10/2012-051. Available at SSRN: https://ssrn.com/abstract=2201505 or http://dx.doi.org/10.2139/ssrn.2201505

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Bingxu Chen

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Suresh M. Sundaresan

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

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