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The missing link: economic exposure and pension plan risk

Published online by Cambridge University Press:  15 July 2015

Paul Sweeting*
Affiliation:
School of Mathematics, Statistics and Actuarial Science, University of Kent, Canterbury, Kent, United Kingdom J.P. Morgan Asset Management, 60 Victoria Embankment, London EC4Y 0JP, United Kingdom
Alexandre Christie
Affiliation:
J.P. Morgan Asset Management, 60 Victoria Embankment, London EC4Y 0JP, United Kingdom
Edward Gladwyn
Affiliation:
J.P. Morgan Asset Management, 60 Victoria Embankment, London EC4Y 0JP, United Kingdom
*
*Correspondence to: P.J. Sweeting, School of Mathematics, Statistics and Actuarial Science, Cornwallis Building, University of Kent, Canterbury, Kent CT2 7NF, United Kingdom. Tel: +44(0)1227 827181; Fax: +44(0)1227 827932; E-mail: p.j.sweeting@kent.ac.uk

Abstract

The funding position of a defined benefit pension plan is often closely linked to the performance of the sponsoring company’s business. For example, a plan sponsor whose financial health is dependent on high oil prices may struggle during periods of oil price weakness. If the pension plan’s assets perform poorly at this time, the ability of the sponsor to address any funding requirement could be restricted precisely when the need for funding is heightened. In this paper, we propose an approach to dealing with joint plan and sponsor risk that can provide protection against extreme adverse events for the sponsor. In particular, adopt a strategy of minimising a portfolio’s expected losses in the event of an assumed drop of x% in the oil price. Our methodology relies on an asset allocation framework that takes into account the impact of serial correlation in asset returns, as well as the negative skewness and leptokurtosis resulting from the non-normal shape of marginal distributions of historical asset returns. We also make use of copulas to measure the dependence between asset class returns.

Type
Papers
Copyright
© Institute and Faculty of Actuaries 2015 

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