The strategic use of options in pension investments
By strategic use of options, I refer to employing options or dynamic trading strategies to structurally obtain non-linear exposures to risky assets. Appropriate dynamic strategies enable investors to shape the return characteristics of their investments in such a way that they match better with their long-term aspirations. In the case of pension funds, these longterm aspirations could pertain to paying out indexed benefit payments at acceptable funding costs. In this paper, I shall investigate to what extent pension funds can benefit from the strategic use of options.
First, we shall discuss Frijns (2005) in which he compares two investment policies in a pragmatic, empirical way. Then we shall extend his analysis by proposing and analysing a third policy in which the exposure to developed equity markets is obtained through options. Secondly, we shall review academic literature in which optimal exposures to risky assets are derived under various assumptions on investment preferences, market efficiency and equilibrium settings.