CORC Report TR-2008-02 Cash flow matching: a risk management approach

We propose a scenario based optimization framework for solving the cash flow matching problem where the time horizon of the liabilities is longer than the maturities of available bonds and the interest rates are uncertain. Standard interest rate models can be used for scenarios generation within this framework. The optimal portfolio is found by minimizing the cost at a specific level of shortfall risk measured by the Conditional Tail Expectation (CTE), also known as Conditional Value-at-Risk (CVaR) or Tail-VaR. The resulting optimization problem is still a linear program (LP) as in the classical cash flow matching approach. This framework can be employed in situations when the classical cash flow matching technique is not applicable.