in a multiperiod simulation framework that allows us to study the impact of payouts. MODELING LIABILITIES Put simply, the liability stream of a typical pension fund is a series of future payments that are unknown as of today. Although actuaries project future payments, they cannot do so with certainty since the actual payments will depend on a number of factors that are unknown as of the projection date. One source of uncertainty is due to mortality rates. Although actuarial mortality tables can be used to predict the life span of the average pensioner, and a fund with many beneficiaries may experience a mortality rate quite like the actuarially assumed average, a random element remains nevertheless. In addition, if the average life expectancy increases due to trends in lifestyle and/or health care, the current mortality table may understate the present value of the benefit obligation. Another source of uncertainty relates to future salary growth. For a benefit plan with a career-pay or final-pay provision, the future benefit obligation will depend on career-average pay or the average pay over the final few years of employment, respectively. When actual salary growth differs from the actuarial assumed growth rates, the projected benefit obligation will require an adjustment. Furthermore, there may be one-time benefit increases that are not reflected in the actuarial salary growth assumptions. For example, many union plans experience periodic increases in the benefit obligation due to collective bargaining. Finally, there may be uncertainty about employee demographics. If the industry or company undergoes structural change, such as increased competition or an acquisition/merger, the company may decide to offer incentives for early retirement or may be forced to terminate a portion of the workforce. Any such change could have a significant impact on the benefit obligation of the pension plan. If the payments were known with certainty, the liability stream would resemble a bond (or portfolio of bonds) that could be priced using the current term structure of interest rates. In the presence of uncertainty about future payments, one can still use this approach, keeping in mind that the value of liabilities calculated in this way is "noisy." This insight leads to an intuitive way for modeling liabilities. We assume the value of liabilities consists of two parts-a bond, which reflects the best guess about future obligations, and a noise term, which reflects the uncertainty of the future payments. The return on the bond as well as its correlation with other assets can be calculated by discounting projected obligations by the current term structure. Alternatively, a publicly traded bond index can be used as a proxy, where the index is levered to match the duration of the liability stream. Mathematically, RUt-RfJ = ¥>(RB,t-ht') + et (10-1) where R t = Total return on the liability index at time t Rf t = Risk-free rate of return RB t = Total return on a bond index et = Noise term