Asset Liability Management (ALM) is a financial technique that can help companies to management the mismatch of asset and liability, and/or cash flow risks. The mismatched risks are caused by different underlying factors affecting the assets and liabilities to move in different direction and magnitude. Asset-liability risk is a leveraged form of risk. The capital of most financial institutions is small relative to the firm’s assets or liabilities, so small percentage changes in assets or liabilities can translate into large percentage changes in capital.
Typically, companies such as banks, insurance companies, pension funds (or their corporate sponsors) adopt such techniques to help them better manage their mismatched asset / liability risks and to ensure that their capital will not be depleted in changing demographic and economic environment.
Techniques for assessing asset-liability risk came to include gap analysis and duration analysis. These facilitated techniques of gap management and duration matching of assets and liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. However, the increasing use of options such as embedded prepayment risks in mortgages or callable debt, posed problems that these traditional analyses could not address. Thus, Monte-Carlos simulation techniques are more appropriate to address the increasing complex financial markets.
Asset Liability Management
