Hedging Long-Term Liabilities

49 Pages Posted: 27 Feb 2016 Last revised: 27 Oct 2019

See all articles by Rogier Quaedvlieg

Rogier Quaedvlieg

European Central Bank (ECB)

Peter C. Schotman

Maastricht University - Department of Finance

Date Written: October 24, 9


Pension funds and life insurers face interest rate risk arising from the duration mismatch of their assets and liabilities. With the aim of hedging long-term liabilities, we estimate variations of a Nelson-Siegel model using swap returns with maturities up to 50 years. We consider versions with three and five factors, as well as constant and time-varying factor loadings. We find that we need either five factors, or time-varying factor loadings in the three factor model to accommodate the long end of the yield curve. The resulting factor hedge portfolios perform poorly due to strong multicollinearity of the factor loadings in the long end, and are easily beaten by a robust, near MSE-optimal, hedging strategy that concentrates its weight on the longest available liquid bond.

Keywords: Factor Models, Risk Management, Term Structure

JEL Classification: G12, C32, C53, C58

Suggested Citation

Quaedvlieg, Rogier and Schotman, Peter C., Hedging Long-Term Liabilities (October 24, 9). Available at SSRN: https://ssrn.com/abstract=2737966 or http://dx.doi.org/10.2139/ssrn.2737966

Rogier Quaedvlieg (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

Peter C. Schotman

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

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