|Institution:||University of Waterloo|
|Keywords:||Cash Balance Pension Plan; Financial Valuation; Dynamic Hedging Strategy|
|Full text PDF:||http://hdl.handle.net/10012/9731|
Cash balance (CB) pension plans make up 25% of all defined benefit plans in the US. The benefits are accumulated at guaranteed crediting rates, the most popular choice is the yield on the 30-year Treasury bond. In this paper, we explore the pricing and hedging of the CB liability using financial theory and models. Due to the fact that crediting rates are often unmarketable, and motivated by the theory of replicating portfolios, we present the performance of a delta hedging strategy. Our results suggest that the performance of the delta hedging strategy is related to the number of factors in the model rather than the number of hedging instruments. In particular, one-factor Hull White and two-factor Hull White model are not capable to construct an effective delta hedging portfolio.