Optimal ALM strategies for defined benefit pension plans

Arun S. Muralidhar, Ronald J. P. van der Wouden

Abstract

ABSTRACT

This paper focuses on the practical implications of certain "alternative" investment strategies for pension plans. It compares these strategies and describes the conditions under which they can lead to efficiency gains for pension plans from an asset-liability management (ALM) context. It is demonstrated that relatively simple strategies can achieve substantial efficiency gains. In a seemingly counterintuitive result, leverage strategies, both static and dynamic, are risk-reducing and hence outperform basic and derivative-based strategies. The result follows since dynamic leveraging replicates, more cost effectively, any derivative strategy in an ALM context. More important, when asset-liability markets are incomplete, asset-liability strategies will outperform asset-only strategies.