Using model to determine the investment strategy Flashcards
(2 cards)
What does asset-liability modeling address
Asset -liability management is a tool that could be used to determine the assets to invest in
given particular objectives
* It addresses questions like:
o How far from perfectly matched investment position an investment is able to move
because of its free assets
o How well the cashflows from chosen set of assets match the liability cashflows in a
range of future economic scenarios
* This helps in setting investment strategy to control the risk of failing to meet objectives
* This method considers the variation in the assets simultaneously with the liabilities
* This is done by constructing a model to project the asset proceeds and liability outgo into the future
Economic assumptions needed for asset-liability model
- Money market :
▪ Future interest rates - Bonds :
▪ Future inflation
▪ Future gross redemption yields (fixed-interest) or real yields ( index-linked ) - For equities :
▪ Future dividend growth
▪ Dividend yields – expressed as a percentage of current price - For property :
▪ Future rental growth rates
▪ Rental yields ( to value property ) - Overseas markets :
▪ Growth rates and yields in each country
▪ Exchange rates
▪ Volatility created by fluctuations in the currency -variance of the exchange rates - Modelling can be deterministic or stochastic
- Deterministic model:
o Parameter values are fixed and the result of running the model is a single outcome
o We would carry out a number of re-runs of the model based on diff set of
assumptions to understand how robust the strategy is - Stochastic model:
o Most appropriate way of allowing for volatility and uncertainty underlying the
assets and liabilities
o At least one parameter is assigned a probability distribution
o Model is run many times to generate a distribution of outcomes
▪ Encourages the investor to formulate explicit objectives
▪ Objectives should be quantifiable and measurable
