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Quantile hedging and its application to life insurance

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  • Melnikov Alexander
  • Skornyakova Victoria
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    Abstract

    The paper develops the method of quantile hedging in a two-factor jump-diffusion market. The exact formulae of the maximal successful hedging set for an option to exchange one asset for another are given. These results are applied to a class of equity-linked life insurance contracts called “pure endowments with a guarantee”. In our setting, the pay-off functions of these insurance contracts are equal to the maximum of two risky assets in a two-factor jump-diffusion model conditioned by the survival status of the insured. The first asset is responsible for the maximal size of future profits, while the second provides a flexible guarantee to the insured. Based on quantile hedging methodology and a generalized Margrabe's formula, the paper describes the valuation and risk management of such mixed finance-insurance instruments.

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    Bibliographic Info

    Article provided by De Gruyter in its journal Statistics & Risk Modeling.

    Volume (Year): 23 (2005)
    Issue (Month): 4/2005 (April)
    Pages: 301-316

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    Handle: RePEc:bpj:strimo:v:23:y:2005:i:4/2005:p:301-316:n:3

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    Cited by:
    1. Klusik, Przemyslaw & Palmowski, Zbigniew, 2011. "Quantile hedging for equity-linked contracts," Insurance: Mathematics and Economics, Elsevier, vol. 48(2), pages 280-286, March.
    2. Melnikov, Alexander & Smirnov, Ivan, 2012. "Dynamic hedging of conditional value-at-risk," Insurance: Mathematics and Economics, Elsevier, vol. 51(1), pages 182-190.
    3. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.

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