Asset-Liability Management

Financial entities such as banks, insurance companies and pension funds must consider risk from a potential mismatch between their assets--such as loans--and their liabilities which which may include customer bank deposits or future pension payments. For example, risk may arise from a bank’s inability to meet liquidity requirements because have borrowed on a short-term basis and lent on a long- term basis through something such as a mortgage. Another example would be an insurance company that gathers customer premiums (the asset) that must be invested in bonds that have cash flows which match the future payouts (the liability) that will be made to customers. The insurance company must attempt to match their assets and liabilities so that the cash flows from their investments are appropriate given their liabilities. Asset liability management seeks to manage these risks by ensuring a proper mix of balance sheet assets and liabilities.

Asset Liability Management for Personal Finance

A recent article the Journal of Portfolio Management argues that asset liability management is highly relevant and applicable to the field of personal finance, while traditional methods such as mean-variance optimization are not appropriate for private investors. Asset-liability management is a portfolio management technique that attempts to match the nature of duration of the assets and liabilities in the portfolio. For example, defined benefit pension fund managers or insurance company...