Liability-Relative Investing

Abstract

The notion of duration-matching, well-developed in the 1980s in nominal terms, is here extended to the dual durations of price sensitivity to real interest rates and to inflation rates. All assets (and liabilities) can be characterized more accurately using two durations instead of one. Equities and many other assets and instruments have different real interest rate and inflation durations, as does a liability. Duration-matching offers a secondary pension risk control measure after surplus optimization. The author develops a solution that duration-matches assets with the pension liability, and shows how to integrate it with surplus optimization, achieving better pension risk control in the process.