Sensitivity of Pension Fund's Balance Sheet: a non-linear risk factor approach

In this paper, we study the funding situation of a representative pension fund when it is exposed to extreme shocks of financial markets. We measure the exposure of both asset and liability sides of the fund’s balance sheet and especially when the benefit obligations use a market based discount rate. By assigning different market indexes to the main items of the fund’s balance sheet, we are able to compute the expected funded status conditionally on extreme shocks to different financial markets. We also take into account the links between the corresponding indexes thanks to the CVine Risk Factor (CVRF) model combining factors and copulas. In particular we are able to measure the exposure of the funding status of the fund to extreme shocks to different risk factors (equity, bond, real estate etc...). We find that the fund is particularly exposed to large shocks to the equity risk factor, even if diversification benefits can exist because such shocks simultaneously induce a drop in the asset values and a decrease in the discounted value of the liabilities. However, the first decrease is larger than the second one, thus the funding situation is declined.