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The Journal of Portfolio Management

The Journal of Portfolio Management

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Article

Liability-Driven Investment with Downside
Risk

Andrew Ang, Bingxu Chen and Suresh Sundaresan
The Journal of Portfolio Management Fall 2013, 40 (1) 71-87; DOI: https://doi.org/10.3905/jpm.2013.40.1.071
Andrew Ang
is the Ann F. Kaplan Professor of Business at Columbia Business School and NBER in New York, NY.
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  • For correspondence: aa610@columbia.edu
Bingxu Chen
is a doctoral candidate at Columbia Business School in New York, NY.
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  • For correspondence: bchen14@gsb.columbia.edu
Suresh Sundaresan
is the Chase Manhattan Bank Professor of Economics and Finance Columbia Business School in New York, NY.
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  • For correspondence: ms122@columbia.edu
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Abstract

The authors develop a liability-driven investment framework that incorporates downside risk penalties for not meeting liabilities. The shortfall between the asset and liabilities can be valued as an option that swaps the value of the endogenously determined optimal portfolio for the value of the liabilities. The optimal portfolio selection exhibits endogenous risk aversion and, as the funding ratio deviates from the fully funded case in both directions, effective risk aversion decreases. When funding is low, the manager swings for the fences to take on risk, betting on the chance that liabilities can be covered. Over-funded plans also can afford to take on more risk, as liabilities are already well covered and so invest aggressively in risky securities.

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The Journal of Portfolio Management: 40 (1)
The Journal of Portfolio Management
Vol. 40, Issue 1
Fall 2013
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Liability-Driven Investment with Downside
Risk
Andrew Ang, Bingxu Chen, Suresh Sundaresan
The Journal of Portfolio Management Oct 2013, 40 (1) 71-87; DOI: 10.3905/jpm.2013.40.1.071

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Liability-Driven Investment with Downside
Risk
Andrew Ang, Bingxu Chen, Suresh Sundaresan
The Journal of Portfolio Management Oct 2013, 40 (1) 71-87; DOI: 10.3905/jpm.2013.40.1.071
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  • Article
    • Abstract
    • MODEL
    • LIABILITY-DRIVEN INVESTMENT WITH DOWNSIDE RISK
    • EMPIRICAL APPLICATION
    • CASH AND EQUITIES
    • CONCLUSION
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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