Bridge over ocean
1 September 2004 Financial Analysts Journal Volume 60, Issue 5

TIPS, the Dual Duration, and the Pension Plan

  1. Laurence B. Siegel
  2. M. Barton Waring

By defining “duration” as the sensitivity of an asset's price to changes in some other variable, one may characterize any asset as having an inflation duration, Di, and a real-interest-rate duration, Dr. Unlike nominal bonds, for which Di = Dr, inflation-linked bonds, such as Treasury Inflation-Indexed Securities (commonly called TIPS), have different values for Di and Dr. Defined-benefit pension liabilities also have different values for Di and Dr. Such liabilities can be modeled as bonds (or portfolios of bonds and equities or other assets) held short. Thus, by appropriately combining TIPS and nominal bonds, a manager can build a portfolio that has the same inflation duration and real-interest-rate duration as the liability stream. Equities also have different values for Di and Dr, so the interaction of equities with TIPS and nominal bonds can be exploited in forming efficient pension portfolios—particularly in defeasing various liability streams.

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