Pension Liquidity Risk *
91 Pages Posted: 25 Jun 2023 Last revised: 14 Apr 2024
Date Written: June 20, 2023
Abstract
Pension funds use interest rate swaps to hedge the interest rate risk arising from their liabilities. Analyzing regulatory data on Dutch pension funds, we find that interest rate hedging exposes pension funds to significant liquidity risk due to margin calls, which can exceed 10% of their total assets when rates rise. We first trace swap usage back to pension regulation and show that pension funds with tighter regulatory constraints use swaps more aggressively. When faced with margin calls, we demonstrate that pension funds sell safe and medium-term government bonds. This procyclical selling behavior adversely affects the prices of these bonds.
Keywords: Pension funds, fixed income, interest rate swaps, liability hedging, liquidity risk, margin calls, price impact. JEL: E43, G12, G18
JEL Classification: E43, G12, G18
Suggested Citation: Suggested Citation