Mean-variance principle of managing cointegrated risky assets and random liabilities

Abstract

Using the diffusion limit of the discrete-time error correction model of cointegration for risky assets and geometric Brownian motion for the value of liabilities, we solve the asset-liability management (ALM) problem using the theory of backward stochastic differential equations. The solutions of the ALM policy and the efficient frontier in terms of surplus are obtained as closed-form formulas. We numerically examine the impact of cointegration to the trade-off between risk and return in managing cointegrated risky assets and random liabilities.