2015 Institutional IPS - 2A AO vs ALM

Contrast the liability risk exposure.


AO assumes liability has no risk.

  • ? Don’t see anywhere in the book has this assumption. Wouldn’t AO doesn’t consider risk of liability make more sense?

This confused me a bit too. In my answer, I just wrote liability risk is irrelevant for AO approach. I hope that’s the same thing.

I would agree that is an irresponsible way of viewing AO. What you mentioned is more rational than assuming AO assumes liabilities have NO risk.

I think it would be more accurate if they said AO assumes liabilities have no MARKET risk. Not considering liabilities assumes their PV remains the same which assumes they have no market risk, among other risks. I can buy that. I find it hard to buy AO assumes liabilities have NO risk at all.

Thanks guys. Glad to see I’m not the only who doesn’t agree with the answer.

Thanks guys. Glad to see I’m not the only who doesn’t agree with the answer.

It assumes liabilities has no risk, is correct.

It’s an AO approach, remember? For all it cares, liabilities don’t exist.

Not sure if this is accurate.

AO uses a required return and assumes the liabilities have no market risk. The inherit risk of the liabilities is reflected in the required return.

OK, found this in the book:

Selecting portfolios from an asset-only perspective implicitly assumes that the liability has no risk at all; at least none that is market related. By ‘market related’ we mean that the exposure is influenced by market related factors such as interest rates, inflation, or economic growth. However, pension liabilities, representing the present value of deferred wages, by their very nature are driven by economics and have many market related exposures

Shall I assume that means AO assumes liablity has no market related risk? I can’t belive the exam took part of the sentence as the answer.