A Tutorial on Asset Liability Management

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By: Tara Keshar Nanda Baidya (from IFORS News June 2012)

The first author was invited by a big energy company in Brazil to coordinate an Asset Liability Management Project. The objective was to develop a model to help its executives make decisions that could minimize the cost and risks of borrowing, which amount to hundreds of billions of dollars. The company needs to choose the source of borrowing and the type, timing and terms of debt to use within a multi period framework. Contributing to the difficulty is the uncertainty of important variables such as, the price of oil and its derivatives (like kerosene, gasoline, diesel, and liquefied gases); the interest rate for different currencies in various international financial markets; and the exchange rates among different currencies. Since they are random variables, they can be described using a scenario tree. This problem requires a multi period model that emphasizes the need to meet liability in each period for a finite horizon (e.g., 50 years). Since the values of both assets and liabilities are random in nature, a stochastic programming approach is used.

Link to material: http://ifors.org/wiki/tutorials-newsletter/asset-liability-mgt.pdf

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