Dynamic asset–liability management in a Markov market with stochastic cash flows

Yao, Haixiang, Li, Xun, Hao, Zhifeng and Li, Yong (2016) Dynamic asset–liability management in a Markov market with stochastic cash flows. Quantitative Finance, 1-23. doi:10.1080/14697688.2016.1151070


Author Yao, Haixiang
Li, Xun
Hao, Zhifeng
Li, Yong
Title Dynamic asset–liability management in a Markov market with stochastic cash flows
Journal name Quantitative Finance   Check publisher's open access policy
ISSN 1469-7696
1469-7688
Publication date 2016-04-29
Year available 2016
Sub-type Article (original research)
DOI 10.1080/14697688.2016.1151070
Open Access Status Not Open Access
Start page 1
End page 23
Total pages 23
Place of publication Abingdon, Oxon, United Kingdom
Publisher Routledge
Collection year 2017
Language eng
Abstract This paper provides a general model to investigate an asset–liability management (ALM) problem in a Markov regime-switching market in a multi-period mean–variance (M–V) framework. Emphasis is placed on the stochastic cash flows in both wealth and liability dynamic processes, and the optimal investment and liquidity management strategies in achieving the M–V bi-objective of terminal surplus are evaluated. In this model, not only the asset returns and liability returns, but also the cash flows depend on the stochastic market states, which are assumed to follow a discrete-time Markov chain. Adopting the dynamic programming approach, the matrix theory and the Lagrange dual principle, we obtain closed-form expressions for the efficient investment strategy. Our proposed model is examined through empirical studies of a defined contribution pension fund. In-sample results show that, given the same risk level, an ALM investor (a) starting in a bear market can expect a higher return compared to beginning in a bull market and (b) has a lower expected return when there are major cash flow problems. The effects of the investment horizon and state-switching probability on the efficient frontier are also discussed. Out-of-sample analyses show the dynamic optimal liquidity management process. An ALM investor using our model can achieve his or her surplus objective in advance and with a minimum variance close to zero.
Keyword Asset–liability management
Efficient investment strategy
Markov regime-switching
Multi-period mean–variance model
Stochastic cash flow
Q-Index Code C1
Q-Index Status Provisional Code
Institutional Status UQ

Document type: Journal Article
Sub-type: Article (original research)
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