Optimal Long-Term Allocation with Pension Fund Liabilities

61 Pages Posted: 19 Oct 2014 Last revised: 20 Oct 2014

See all articles by Eric Jondeau

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute

Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Date Written: October 1, 2014

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: Systematic Risk, Skewness, Predictability, Trading Strategies

JEL Classification: G11, G12, G14, G17

Suggested Citation

Jondeau, Eric and Rockinger, Georg Michael, Optimal Long-Term Allocation with Pension Fund Liabilities (October 1, 2014). Swiss Finance Institute Research Paper No. 14-58. Available at SSRN: https://ssrn.com/abstract=2511308 or http://dx.doi.org/10.2139/ssrn.2511308

Eric Jondeau (Contact Author)

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://www.hec.unil.ch/ejondeau/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Georg Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland
+41 21 728 3348 (Phone)
+41+21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/mrockinger

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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