ALM Models in a Danish Perspective

Dennis Christiansen & Kennie Nielebock Hansen

Student thesis: Master thesis


Because Danish pension funds used to guaranteed a minimum investment return of up to 4.5 percent, the current market conditions of low interest rates and increases in longevity poses a challenge through proper risk management to honor future liabilities. Given the limited literature in the specific area of with-profit schemes, papers investigating assetliability management models relevant to public pensions and defined benefit schemes have encouraged the study of with-profit schemes in a Danish perspective. With the introduction of Solvency II, to increase the capital requirements and reduce the probability of default, the pension funds are expected to accumulate a larger amount of capital to keep the funding ratio above one. While asset-liability management models can be used to stochastically model the future shocks of the economy, the objective of it can very significantly, with the purpose of this paper being a maximization of collective bonus potential through comparing four different portfolio theories. One of the difficulties of estimating an asset-liability management model, to achieve a correct assessment of the future shocks to the economy, through the use of stochastic models such as Vasicek and Geometric Brownian Motion, is the sensitivity to the selected time horizon of available data. To understand the influencing factors and the level of sensitivity to the asset-liability management model, a practical working model within the Danish pension sector is constructed by applying a set of realistic assumption. The output shed lights on how different portfolio theories maximize the collective bonus potential, while assessing how it is influenced by shocking or adjusting of the variables of the model. Through a comparison between the four portfolio theories proposed, the Sortino ratio is discovered to outperform the tangency portfolio in the constructed default model, while the minimum variance portfolio outperform the risk parity in providing the lowest variance. By reducing the level of the risk-based constraint imposed by Solvency II, the probability of default increases from 0 to 5-10 percent. To reduce the exposure, the implications of a of risk factors are discussed, suggesting a focus driven by shortfall risk and heding instrument. In conclusion, the asset-liability management model proves to be a superior risk management tool, for the continued use in the Danish pension market.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2018
Number of pages134