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Portfolio Insurance Strategies for Pension Funds

Professor: 
Type: 
Master's Thesis
Corporate Partner: 
Union Bancaire Privée
Date Published: 
December 14, 2015

The presence of minimum funding ratio constraints and liabilities necessitate that pension funds apply sound asset-liability management (ALM). In practice, this concept has not yet completely asserted itself. This study demonstrates that portfolio insurance strategies are effective instruments with respect to short-term constraints and pension obligations since they guarantee a minimum wealth level at some specified point in time, while participation in the performance of some reference portfolio is allowed (Basak (2002) and Grossman and Vila (1989)). Using the real-world liability data of a typical Swiss pension fund, the empirical analysis finds that different variations of the constant proportion portfolio insurance (CPPI) strategy perform better with respect to the final funding ratio distribution than a constant mix strategy under a great number of different market conditions. The filtered historical simulation (FHS) approach is applied to generate a variety of different scenarios. The number of violations of the minimum funding ratio constraint is small for a pension plan that is, relative to the imposed minimum funding level, sufficiently funded at the beginning. Furthermore, it is shown that the introduction of a maximum funding ratio constraint can often reduce the cost of downside protection, while—on the contrary—applying a dynamic multiplier as proposed by Lee et al. (2008) leads to higher costs without sufficiently reducing the shortfall probabilities.