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Liability Driven Investments under a Benchmark Based Approach

In this paper, we present an alternative approach as a suitable framework under which liability driven investments can be valued and hedged. This benchmark approach values both assets and liabilities consistently under the real world probability measure using the best performing portfolio, the growth optimal portfolio, as benchmark and numeraire. The benchmark approach identifies the investment strategy which is replicating a given claim at minimal cost. Should the liability under consideration be subject to nonhedgeable risk, e.g. mortality risk, benchmarked risk minimization identifies with its real world pricing formula the investment strategy which minimizes in a practical sense the price of a given claim and minimizes the benchmarked profit and loss from hedging. The application of the approach will be demonstrated for pensions. A least expensive pension scheme will be described that allows one in a fair and transparent manner to hedge in the least expensive way with minimal risk the post retirement payments for its members.

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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 325.

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Length: 25 pages
Date of creation: 01 Feb 2013
Date of revision:
Handle: RePEc:uts:rpaper:325
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  1. Truc Le & Eckhard Platen, 2006. "Approximating the Growth Optimal Portfolio with a Diversified World Stock Index," Research Paper Series 180, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Eckhard Platen & Hardy Hulley, 2008. "Hedging for the Long Run," Research Paper Series 214, Quantitative Finance Research Centre, University of Technology, Sydney.
  3. Eckhard Platen, 2001. "A Minimal Financial Market Model," Research Paper Series 48, Quantitative Finance Research Centre, University of Technology, Sydney.
  4. Markowitz, Harry M, 1976. "Investment for the Long Run: New Evidence for an Old Rule," Journal of Finance, American Finance Association, vol. 31(5), pages 1273-86, December.
  5. Eckhard Platen, 2004. "A Benchmark Approach to Finance," Research Paper Series 138, Quantitative Finance Research Centre, University of Technology, Sydney.
  6. Eckhard Platen & Renata Rendek, 2007. "Empirical Evidence on Student-t Log-Returns of Diversified World Stock Indices," Research Paper Series 194, Quantitative Finance Research Centre, University of Technology, Sydney.
  7. Henry Allen Latane, 1959. "Criteria for Choice Among Risky Ventures," Journal of Political Economy, University of Chicago Press, vol. 67, pages 144.
  8. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.
  9. Eckhard Platen, 2001. "Arbitrage in Continuous Complete Markets," Research Paper Series 72, Quantitative Finance Research Centre, University of Technology, Sydney.
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