Liability driven investments with a link to behavioral finance

Liability driven investments with a link to behavioral finance

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Speaker(s): Markus Wahl (Technical University of Munich)

Liability driven investment (LDI) strategies that take stochastic liabilities into account have become increasingly important for insurance companies and pension funds due to market developments such as low interest rates, high volatility and changes in regulatory requirements. We consider stochastic liabilities in a portfolio optimization framework and include aspects from behavioral finance, in particular cumulative prospect theory (CPT). We study LDI strategies with extended preference structures and probability distortion and derive analytical solutions for a CPT portfolio optimization problem in an LDI context. Within a case study, we compare the optimal investment strategies to existing LDI approaches within traditional frameworks such as the surplus optimization presented in Sharpe and Tint (1990) and the funding ratio optimization in an expected utility framework as introduced in Martellini (2006).

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