Edhec-Risk
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Asset-Liability Management - December 14, 2010

An Integrated Approach to Asset-Liability Management: Capital Structure Choices, Pension Fund Allocation Decisions and the Rational Pricing of Liability Streams

"An Integrated Approach to Asset-Liability Management: Capital Structure Choices, Pension Fund Allocation Decisions and the Rational Pricing of Liability Streams" is drawn from the BNP Paribas Investment Partners research chair on “Asset-Liability Management and Institutional Investment Management” at EDHEC-Risk Institute.

Correctly assessing the value of a pension plan in deficit with a weak sponsor company is a real challenge given that no comprehensive model is currently available for the joint quantitative analysis of capital structure choices, pension fund allocation decisions and their impact on rational pricing of liability streams.

This publication is an attempt to fill this gap by analysing the valuation of pension liabilities regarded as defaultable claims issued by the sponsor company to workers and pensioners in the context of an integrated model of capital structure.

Our results show that leverage decisions have a strong impact on the fair value of pension liabilities, and conversely that the presence of a pension plan decreases the optimal leverage ratio. We also find that interior optimal values may exist for allocation decisions. In an extension to a dynamic setting we find that risk-controlled strategies allow the pension fund to take more risks, which has a positive effect on equity value, while protecting pensioners.

Our model has important policy implications in that it provides a first step towards a much needed methodological framework for the design of firm-specific regulatory constraints and accounting valuation principles.


URL for this document:
http://www.edhec-risk.com/features/RISKArticle.2010-12-14.5240

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