Hedging Long-Term Liabilities

Abstract Pension funds and life insurers face interest rate risk arising from the duration mismatch of their assets and liabilities. With the aim of hedging long-term liabilities, we estimate variations of a Nelson–Siegel model using swap returns with maturities up to 50 years. We consider versions...

Full description

Saved in:
Bibliographic Details
Published inJournal of financial econometrics Vol. 20; no. 3; pp. 505 - 538
Main Authors Quaedvlieg, Rogier, Schotman, Peter
Format Journal Article
LanguageEnglish
Published Oxford University Press 01.07.2022
Subjects
C53
risk management
C32
C58
term structure
G12
factor models
Online AccessGet full text

Cover

More Information
Summary:Abstract Pension funds and life insurers face interest rate risk arising from the duration mismatch of their assets and liabilities. With the aim of hedging long-term liabilities, we estimate variations of a Nelson–Siegel model using swap returns with maturities up to 50 years. We consider versions with three and five factors, as well as constant and time-varying factor loadings. We find that we need either five factors or time-varying factor loadings in the three-factor model to accommodate the long end of the yield curve. The resulting factor hedge portfolios perform poorly due to strong multicollinearity of the factor loadings in the long end, and are easily beaten by a robust, near Mean-Squared-Error- optimal, hedging strategy that concentrates its weight on the longest available liquid bond.
ISSN:1479-8409
1479-8417
DOI:10.1093/jjfinec/nbaa027