Strategic Interest Rate Hedges, or How Derivatives Can Help Solve the Pension Fund Crisis Part Ii

Abstract

In this paper we use a scenario-based ALM model to study the impact of different interest rate derivatives strategies on the risk-return profile of a defined benefit pension fund. The results show that properly constructed hedging strategies using swaps and swaptions can add substantial value. Increased risk perception due to fair value accounting and regulation can be dealt with effectively via these techniques. The results are robust with respect to the assumed interest rate mean reversion level. An expected rise in interest rates is therefore no reason to refrain from hedging.

Keywords: Pension fund, swap, swaption, hedging, interest rate risk