Kristy Jansen, Sven Klingler, Angelo Ranaldo, and Patty Duijm are working on a project sponsored by Inquire Europe. The project is scheduled to be finalized early 2024.
Pension funds are huge institutional investors with long-term liabilities that are highly sensitive to fluctuations in interest rates and total assets often surpassing the gross domestic product (GDP) of their home countries. To hedge the interest rate risk arising from their liabilities, pension funds invest in long-dated bonds and often receive the fixed rate in long-dated interest rate swaps. That this hedging behavior can expose pension funds to liquidity risk due to margin calls became obvious in October 2022, when a sudden spike in British interest rates triggered huge margin calls and eventual fire sales in the U.K. pension system (e.g., U.K. Parliament, 2022). Despite this shocking episode, little is known about the liquidity risk in the global pension system. Is there a systematic link between interest rate hedging and liquidity risk in the pension sector? If so, how do pension funds respond to liquidity shocks and can these responses have a destabilizing effect on financial markets? To address these questions, we utilize unique regulatory data on Dutch pension funds and study the link between derivatives positions and asset allocations.
Read more in the extended summary on our website.