ON Integrated Chance Constraints in ALM for Pension Funds

TL;DR

This paper introduces integrated chance constraints (ICC) into asset-liability management for pension funds, comparing one-period and multi-period approaches, and demonstrates that multi-period ICC provides a safer, more prudent risk management method with similar costs.

Contribution

The paper develops a multistage stochastic linear programming model incorporating both one-period and multi-period integrated chance constraints for pension fund management.

Findings

MICC is more restrictive and safer than OICC.

Optimal decisions differ between OICC and MICC, but total costs are similar.

MICC offers a more prudent risk management approach.

Abstract

We discuss the role of integrated chance constraints (ICC) as quantitative risk constraints in asset and liability management (ALM) for pension funds. We define two types of ICC: the one period integrated chance constraint (OICC) and the multiperiod integrated chance constraint (MICC). As their names suggest, the OICC covers only one period whereas several periods are taken into account with the MICC. A multistage stochastic linear programming model is therefore developed for this purpose and a special mention is paid to the modeling of the MICC. Based on a numerical example, we firstly analyse the effects of the OICC and the MICC on the optimal decisions (asset allocation and contribution rate) of a pension fund. By definition, the MICC is more restrictive and safer compared to the OICC. Secondly, we quantify this MICC safety increase. The results show that although the optimal decisions from the OICC and the MICC differ, the total costs are very close, showing that the MICC is definitely a better approach since it is more prudent.