By Eddy H. Verbiest

A white-box deterministic system simulates long-term LDI cashflows using as input J.P.Morgan Long Term Capital Market Assumptions adapted to make them interest rate dependent. Trading, coupons and dividends provide cashflows to pay liabilities and extract excess cash to stakeholders while maintaining the allocation weights and target lifes. Performance is measured by FixPct: the annually extractable Fixed Percentage of remaining liabilities to run-off to zero. This measure summarizes the interplay of drivers over many decades and allows easy comparison of allocations and mapping of the dependency of results on models and assumptions that are parameterized for easy adaptation and import from external sources like JPM LTCMA. LDI-risk is then the width of the FixPct distribution over market risk while a holistic risk assessment includes all mapped dependencies of which stress-tests are a subset. FixPct as function of market risk facilitates the specification of a risk appetite, funding policy and capital management policy. Results confirm JPM’s view that current market conditions favor switching from a classic 60-40 equity-bond allocation to a full-spectrum allocation including among others private debt and equity, real estate and infrastructure. This improves FixPct by about 1.5% based on 21Q3 interest rates and rates of 22Q1 raise FixPct by about 0.5% for full-spectrum and by 0.3% for 60-40. FixPct is about linear with funding (initial assets/liabilities) for all market probabilities. Superiority of full-spectrum over 60-40 is robust towards changes in interest rate, spread, variance and correlation assumptions. The system can detail to the level of individual bonds what remains here out of scope. Main purpose is to enable insightful decisions to complement shorter-term or regulatory information.

Source @PaperSSRN