ALM, International Financial Reporting Standards and Corporate Finance
Research area: meso, finance
Department: Pension Fund Consultancy (PFC)
Supervisor: drs. Jitske van London
Description: More and more Dutch multinationals are adopting the International Financial Reporting Standards (IFRS). This means that the way in which pension costs and surpluses occur on the balance sheet and the profit and loss account of the corporation differs strongly from the way in which this is done under conventional accounting methods. These differences have a strong impact on the way in which corporations view the contribution risks they are exposed to within pension funds and thereby also on the risk and return tradeoffs that are made in ALM projects of the pension funds. Under these accounting rules, the assets and liabilities of all pension funds of a multinational corporation are valued by the same method. This allows for an assessment of the worldwide pension risks of a multinational corporation. Furthermore, the corporation and the pension funds are exposed to a number of identical risk drivers which calls for an integral analysis of the total financial risks of a multinational corporation. The objective of this project is to work on the foundations of this worldwide approach to ALM by finding out the needs for and defining corporate ALM while taking into account the restrictions from the corporation side such as governance issues and the legal independency of pension funds. Also studying the specific IAS accounting rules can be a part of the assignment.
Background information:
Bezooyen, J. van (2003), “Pensions, the Corporate Perspective”, Fiducie, Volume 11, nr. 3.
Vos, M and J. van Londen (2005), “Corporate Asset Libility Management: An integral model for supporting pension and corporate descissions”, Medium Econometrische Toepassingen, Volume 13, nr. 2. (www.ortec-finance.com/english/publications)
ALM and Intergenerational Solidarity
Research area: meso, finance
Department: Pension Fund Consultancy (PFC)
Supervisor: Jeroen van der Bosch and drs. Nicole van der Zee
Description: One of the reasons of existence of pension funds is that they accommodate risk sharing between generations. Because the Dutch (second pillar) pension system is a system in which participants pay now to save for benefit payments in the future, by means of additional contributions, younger generations can help older generations. The other way around, older generations can help younger generations by giving up parts of the indexation compensation of their pension rights. In the past years, research effort has been put into quantifying the “value” of this type of solidarity. Furthermore, there are a number of developments in our society that put pressure on this type of solidarity. One of these is the rise of (collective) defined contribution schemes which transfer all the risk (but also the returns) onto the individuals. The objective of this project is to build on the research done on the value of the intergenerational solidarity and to place this in the light of recent social developments.
Background information:
Boender, C.G.E., S. van Hoogdalem, R.M.A. Jansweijer en E. van Lochem (2000), “Intergenerationele Solidariteit en Individualiteit in de Tweede Pensioenpijler: Een Scenario-Analyse”, Wetenschappelijke Raad voor het Regeringsbeleid, Den Haag, rapport 114. (www.ortec-finance.com/english/publications)
Boender, C.G.E., A.L. Bovenberg, S. van Hoogdalem and T.E. Nijman (2007), “Optimal risk-sharing in private and collective pension contracts”, in Costs and Benefits of Collective Pension Systems, edited by O.W. Steenbeek and S.G. van der Lecq, 2007. (www.ortec-finance.com/english/publications)
Currency Management for Long-Term Investors
Research area: meso, quantitative finance
Department: ORTEC Centre for Financial Research (OCFR)
Supervisor: dr. Henk Hoek and drs. Loranne van Lieshout
Description: Long term investors, like pension funds, typically not only invest in domestic assets but also in foreign assets, and therefore face currency risk. Conventional wisdom claims that investors should fully hedge their currency risk exposure, as not hedging results in higher volatility but not in higher expected returns. Froot (1993) however argued that currency hedging only lowers short-term volatility but actually increases long term volatility. Also, as discussed in Campbell et. al. (2007) due to correlations between currency returns and asset returns, the optimal hedge ratio for foreign bonds and foreign equity portfolios should be different. The objective of this project is to analyze the optimal strategic currency hedge for a pension fund. Although a pension fund is a long term investor and is confronted with long term volatility, it can also not ignore short term volatility. High short term volatility might result in more volatile contributions and indexations and is therefore undesirable from the perspective of the stakeholders of the pension fund.
Background information:
Campbell, J.Y., K. Serfaty-de Medeiros and L.M.Viceira (2007), “Global Currency Hedging”, Working Paper. (www.hbs.edu/research/pdf/07-084.pdf).
Campbell, J.Y., L.M. Viceira and J.S. White (2002), “Foreign Currency for Long-Term investors”, NBER Working Paper No. 9075.
Froot, K.A. (1993), “Currency Hedging Over Long Horizons”, NBER Working Paper No. 4355.
Dynamic Life Cycle Investing
Research area: micro, finance
Department: Financial Planning (FinX, www.finx.nl)
Supervisor: Ronald Janssen
Description: Life cycle investment products are becoming more and more popular. This increased interest stems from new regulation (“Pensioenwet”), responsible investing (“zorgplicht”) and claims of recent years. However, in the advisory processes of individuals several aspects of life cycle investing are not taken into account properly yet. Instead it is often suggested as if one life cycle mix would be appropriate for all situations of individuals which is very likely not the case. One question if for example how the investment risk should be decreased exactly. Should this be done in a simple linear fashion, is this dependent on the remaining investment horizon, the initial asset allocation, etc.? Also is there still little attention for cash flow aspects. What are for example the effects of lump sum investments or periodic investments? And what to think about the purposes on which the investment proceedings need to be spend at the end of the horizon? The objective of this project is to investigate how a dynamic life cycle investment strategy can be defined and to identify the key differences between a “standard” and a dynamic life cycle strategy.
Background information:
A.L. Bovenberg, R. Koijen, T.E. Nijman and C. Teulings (2007), “Saving and Investing over the Life Cycle and the role of Collective Pension Funds”, Netspar Panel Paper nr. 1.
Papers presented at the seminar “The Future of Life-Cycle Saving & Investing”, October 2006, Boston. (www.bos.frb.org/economic/conf/lcsi2006/index.htm)
Interpolation Methods for Embedded Options
Research area: mathematical finance
Department: Insurance Advisory
Supervisor: dr. David van Bragt
Description: Due to external developments like the upcoming new accounting standards (IFRS phase II) and new regulatory frameworks (Solvency II) and due to developments in internal risk and return management, ALM models for insurance companies need to determine the market value of the insurance liabilities. A first method to value the embedded options in these liabilities is to apply approximating closed-form option formulas. For very complex options, an alternative approach can also be used. This approach starts by first defining a limited number of states of the world (for example different interest-rate levels) and then using risk-neutral Monte Carlo methods to determine the market value in each of these states. In every point of a set of economic scenarios, the value of the options can subsequently be estimated by means of interpolation between the pre-calculated and tabulated values. This research project builds on earlier research and existing algorithms. The specific objectives of this project are to further refine these algorithms and to find an appropriate method to determine the interest-rate sensitivities of the options for different terms to maturity.
Background information:
Van Bragt, D. and H. Steehouwer (2007), “Recent Trends in Asset and Liability Modeling for Life Insurers”, OCFR Methodological Paper No. 2007-01.
(www.ortec-finance.com/english/publications)
Empirical Volatility and Correlation Dynamics
Research area: econometrics
Department: ORTEC Centre for Financial Research (OCFR)
Supervisor: dr. Hens Steehouwer
Description: Conventional stochastic scenario models that are used for ALM purposes are often based, or at least simulate, at an annual frequency because of the long horizons (say 20 years) of the application of the scenarios. During recent years however the need has come that these scenario models also provide scenarios at higher observation frequencies (say monthly) and possibly also with a shorter horizon (say annual). This need stems for the required consistent integration of long term ALM, medium term implementation and short term monitoring models and from the need to be able to analyze higher frequency policy actions (for example duration matching or rebalancing rules). To be able to model such higher frequency scenarios, it essential to first have a clear picture of the empirical behavior of financial and economic time series in this respect. Besides seasonal developments, one often thinks of volatilities and correlations that vary though time, for example based on more structural business or economic conditions of that moment (business cycle) or more “random” variation due to periods or turbulence on the financial markets. The objective of this project is to collect and study the (empirical) existing literature on the topic of time varying volatilities and correlations, to perform own empirical research based on a specific frequency domain methodology and finally to suggest ways of modeling the typically observed empirical behavior within the context of an existing scenario model.
Background information:
Steehouwer H. (2005), “Macroeconomic Scenarios and Reality. A Frequency Domain Approach for Analyzing Historical Time Series and Generating Scenarios for the Future”, PhD thesis, Free University of Amsterdam. (www.ortec-finance.com/english/publications)
