ALM?

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BMiller12

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It’s been a couple months since I’ve read fixed income. I know classical immunization involves matching asset and liability duration…but does it also require that asset value = liability value? If so, how is there a surplus to manage if assets equal liabilities? I’m reading about bank portfolio management now and it’s discussing using ALM to match durations and stabilize the surplus. Does this mean they’re applying the contingent immunization brand of ALM, which I thought was the only way you had a surplus while still using ALM?
thanks in advance!
 
ladg is used by the banks.
effect of leverage on the duration of A & L
 
ladg = wtf?
Gives us a clue CPK, there is no point responding in code!?
L3 is hard enough as it is, as you well know!
Cheers…..
 
leverage adjusted duration gap - Da - (D/A) * Dl
Da = Duration Assets, D = Weight of liabilities (Market Value), A=Market Value of Assets, Dl = Duration of Liabilities
The leverage-adjusted duration gap is defined as DA – kDL, where DA is the duration of assets, DL is the duration of liabilities, and k = L/A, the ratio of the market value of liabilities (L) to the market value of assets (A). The leverage- adjusted duration gap measures a bank’s overall interest rate exposure. For a positive interest rate shock (unexpected increase in rates), the market value of net worth will decrease for a bank with a positive gap; be unaffected for a bank with a zero gap (an immunized balance sheet); and increase for a bank with a negative gap.
 
Does ALM require that asset value = liability value or just that durations are matched? If its the former, than what surplus is there to manage? Also, is there an example of matching durations without having to match asset and liability values?
 
there is no point of ALM if Assets and liabilities are not matched. And one of the primary ways to make sure that the two are matched is to a) match the values b) match the durations over the course of the liability’s life.
the ultimate purpose of ALM is to make sure the liability has to be met. and the liability is the benchmark in this approach as well.
Duration matching is a method of risk control - various ways of cash flow matching, immunization, etc. are means to achieve the goal.
 
Than how do insurance companies and DBPs generate surpluses if they manage the assets to equal their liabilities?
Does matching asset and liability duration mean the values are also equal or can durations match without values being equal?
 
surplus = market value of asset - market value of liability
liability = asset - is keeping them close together - that is the benchmark that you need to keep in mind. (also here think notional value of asset = notional value of liability).
This question you are asking is similar to the question of - if you are tracking a benchmark - could you not have an element of tracking risk? The surplus is pretty much like that. If you had a surplus - it is better to have a positive surplus (where assets exceed liabilities) rather than a negative surplus.
 
I get ya. Guess it just seems a little odd that by using ALM and thereby trying to match asset and liabilities that you’re able generate a surplus at the same time. How is that? So even though durations are matched, you can still generate a surplus?
 
Even though the durations are matched, the financial instruments that you are invested in, are not exactly the same as your liabilities. IE a bank could be invested in treasuries or making loans in order to pay its deposits. Since the underlying assets and liabilties are not the same instrument, they could perform differently despite having the same duration.
 
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