Dynamic Strategies for Net Income Generation in a Low Interest Rate Environment

This paper explores some dynamic investment strategies based on interest rate derivatives to generate income. The low interest rate environment makes this question critical to public institutional investors and potentially their asset-liability management. There exists a trade-off between the potential level income generated for the medium/long term on one side, and, the uncertainty of this income and its associated mark-to-market volatility through time, on the other side. First, we develop the foundations of the Libor market model (LMM) initially calibrated using data from swaptions for USD and EUR markets. Then different types of eligible strategies for the stabilization of the net income are provided. The strategies are mostly based on interest rate derivatives – swaps, caps, floors and swaptions –, and they may be partially rule-based and/or self-financed and may allow for tactical decision. Finally, the importance of the institutional framework and the role of the governance are discussed, e.g. the impact of mark-to-market based investment rules on the degree of path-dependency of the implemented strategies.