ost strategic asset allocation analysis considers only the dynamics of asset values and abstracts from the presence of any liabilities. Thirty-five years of academic and applied research have developed a more or less unified theory of investing assets for the long run and capital market equilibria resulting from the optimal investment behavior of individuals. For many investors, this type of analysis is reasonably appropriate. For example, a retired homeowner who has no mortgage and no children can be assumed to have no liabilities, and his or her asset allocation can be analyzed using classical methods. For other types of investors, the abstraction from the presence of liabilities is more troublesome. Pension funds in particular exist for the sole purpose of paying out pensions in the present and future. Ignoring their liability stream can lead to suboptimal asset allocations. In this chapter we investigate the strategic asset allocation process in the presence of liabilities. The presence of liabilities introduces an interesting complexity into the asset allocation problem. Rather than investing to get "the biggest bang for the buck," investors may forgo higher expected returns in order to allocate to an asset that is highly correlated with liabilities. By investing in this manner, they ensure that the value of their assets increases when the value of liabilities does, thereby protecting the surplus. The issues we investigate in the context of our framework are the three drivers of long-term performance: the bond/equity split, the level of diversification, and the duration of the bond portfolio. Our numerical results show that there is a dichotomy between the optimal asset allocations for over- and underfunded plans. The latter must take a large amount of equity risk in order to improve their funding status, while the former may actually be better off with lower equity allocations. Similarly, overfunded plans benefit from global equity diversification, while underfunded plans do not. Finally, the benefit from duration matching the bond portfolio with liabilities is much greater for underfunded than for overfunded plans. From the outset, we outline our approach to modeling liabilities. Subsequently, we analyze the asset allocation decision, where we initially focus on a single-period setup. This framework is a simple extension of the setup without liabilities often studied, in which investments are evaluated by their Sharpe ratios. Subsequently,