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, D i , and a real-interest-rate duration, D r . Unlike nominal bonds, for which D i = D r , inflation-linked bonds, such as Treasury Inflation-Indexed Securities (commonly called TIPS), have different values for D i and D r . Defined-benefit pension liabilities also have different values for D i and D r . 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 D i and D r , so the interaction of equities with TIPS and nominal bonds can be exploited in forming efficient pension portfolios—particularly in defeasing various liability streams.

Author Information

Laurence B. Siegel is director of policy research in the Investment Division of The Ford Foundation, New York.

M. Barton Waring is managing director and head of the Client Advisory Group at Barclays Global Investors, San Francisco.

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