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Liability Driven Investment

7. Other comments

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7.1          Liability Driven Investment is closely allied with Asset Liability Modelling (ALM, aka Asset Liability Management). ALM can be thought of as involving:

 

(a)    Modelling of how assets and liabilities might interact, and then

 

(b)   Managing the assets, liabilities, or both, so that the nature of this interaction is favourable to the entity.

 

Typically in both (a) and (b) there is some trade-off between risk and reward, suitably defined, for the sorts of reasons highlighted in 1.4.

 

7.2          Interestingly, what might be described as ‘state-of-the-art’ ALM seems to differ between insurance/pensions and banking/investment management:

 

In insurance/pensions the focus is principally on:

 

(a)    Projecting assets and liabilities into the future, and from them also deriving potential future behaviour of related features, e.g. solvency, free asset ratio; and

 

(b)   The projections are usually stochastic in nature, i.e. they involve projection of results under many different scenarios.

 

In contrast, in banking/investment management the focus is more often on:

 

(c)    Identifying the extent of the current mismatch between assets and liabilities; and

 

(d)   Quantifying this mismatch via Value-at-Risk, tracking error or other similar risk metrics.

 

7.3          This apparent difference in focus is explored further in Kemp (2005b) and Kemp (2009). Part of it is linked to implicit or explicit assumptions about how rapidly it might be possible for the firms/entities to take remedial action. The apparently different focus also in part reflects presentational preferences within the relevant client types.

 


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