Because it’s pretty obvious, I always thought they are related without questioning it too much. For example a provision for earlier retirement means that the duration of plan liabilities is shorter and so also the time horizon of the plan is shorter.
But doing essay 2017 I found a question where it is stated that increasing or decreasing the discount rate for plan liabilities changes the duration of the plan but NOT the time horizon.
I would agree that changing the discount rate changes the PV (amount) of the plan liabilities, but I don’t understand why it should change the duration of the plan liabilities and why in this case it does not change also the time horizon…
I am getting confused about a concept that I thought to be obvious…
duration is also a sensitivity measure of portfolio value to interest rate changes (in this case, the discount rate). due to the existence of convexity, duration changes as rates change (i.e. it’s not a linear relationship).
time horizon in this case is how much time until retirement and the liabilities are due since we’re talking about time horizon of the liabilities. it’s mostly fixed and an independent variable that is determined at the start of the plan
yes, duration is also the weighted average measure of how long until cash flows are received so confusion is bound to happen.
You got the point and what you are saying makes completely sense (just think of what is duration for fixed income).
time horizon and plan duration are so linked as I said, but in this case only the duration is affected!
thanks!
This is Fu…ing confusing since this is the answer they gave for the 2017 AM subject question!!
‘‘A shorter duration of plan liabilities implies a low ability to take risk, as less time is available for the plan to recover from any unfavorable investment returns’’
Based on the answer they’re giving, they are using duration as a time horizon too…