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DYNAMIC HEDGING STRATEGIES FOR CASH BALANCE PENSION PLANS

Published online by Cambridge University Press:  11 June 2018

Xiaobai Zhu ,
Mary R. Hardy  and
David Saunders
Xiaobai Zhu
Affiliation:
Dept of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario, Canada Email: x32zhu@uwaterloo.ca
Mary R. Hardy*
Affiliation:
Dept of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario, Canada
David Saunders
Affiliation:
Dept of Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario, Canada Email: dsaunders@uwaterloo.ca
*
Email: mary.hardy@uwaterloo.ca
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Abstract

Cash balance pension plans with crediting rates linked to long bond yields are relatively common in the United States, but their liabilities are proving very challenging to hedge. In this paper, we consider dynamic hedge strategies using the one-factor and two-factor Hull White models, based on results for the liability valuation from Hardy et al. (2014). The strategies utilise simple hedge portfolios combining one or two zero-coupon bonds, and a money market account. We assess the effectiveness of the strategies by considering how accurately each one would have hedged a 5-year cash balance liability through the past 20 years, using real-world returns and crediting rates, and assuming parameters calibrated using the information available at the time. We show that there is considerable impact of model and parameter uncertainty, with additional, less severe impact from discrete hedging error and transactions costs. Despite this, the dynamic hedge strategies do manage to stabilize surplus substantially, even through the turbulence of the past two decades.

Keywords

Cash balance pensiondynamic hedgingHull-White model
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 48 , Issue 3 , September 2018 , pp. 1245 - 1275
Copyright
Copyright © Astin Bulletin 2018 

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