Restricted Kalman filter applied to dynamic style analysis of actuarial funds


Adrian Pizzinga, Rua Mario Santos Braga s/n, Instituto de Matemática e Estatística - 7o. andar - Centro, 24020-140, Niterói RJ, Brasil.



We use dynamic style analysis to unveil the strategies followed by Brazilian actuarial funds from January 2004 to August 2008 and investigate whether managers’ decisions were compatible with the intention of protecting the investor against the negative effects of inflation. The main goal of this paper is to show that this methodology is suitable for allowing insurance companies to increase their capacity to monitor the behavior of portfolios and to control the amount of risk they assume. The basic steps of the method are to build and/or choose market indexes capable of characterizing the returns of the main securities available and to apply restricted linear state space models estimated with a Kalman filter with exact initialization. The main conclusions of this paper are the following: (1) the use of exact initialization of the Kalman filter promotes numerical stability; (2) there is no need to consider the entire set of market indicators because a subset containing only three indexes spans the relevant space of investment opportunities; and (3) the actuarial funds’ resources were primarily invested in inflation-indexed bonds, but fund managers also left room to adjust their exposure to other assets not directly related to the objective of providing protection against inflation. Copyright © 2011 John Wiley & Sons, Ltd.