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Correlated intensity, counter party risks, and dependent mortalities

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  • Ma, Jin
  • Yun, Youngyun
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    Abstract

    In this paper we use an intensity-based framework to analyze and compute the correlated default probabilities, both in finance and actuarial sciences, following the idea of "change of measure" initiated by Collin-Dufresne et al. (2004). Our method is based on a representation theorem for joint survival probability among an arbitrary number of defaults, which works particularly effectively for certain types of correlated default models, including the counter-party risk models of Jarrow and Yu (2001) and related problems such as the phenomenon of "flight to quality". The results are also useful in studying the recently observed dependent mortality for married couples involving spousal bereavement. In particular we study in details a problem of pricing Universal Variable Life (UVL) insurance products. The explicit formulae for the joint-life status and last-survivor status (or equivalently, the probability distribution of first-to-default and last-to-default in a multi-firm setting) enable us to derive the explicit solution to the indifference pricing formula without using any advanced results in partial differential equations.

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    Bibliographic Info

    Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

    Volume (Year): 47 (2010)
    Issue (Month): 3 (December)
    Pages: 337-351

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    Handle: RePEc:eee:insuma:v:47:y:2010:i:3:p:337-351

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    Web page: http://www.elsevier.com/locate/inca/505554

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    Keywords: Correlated defaults Change of measure Martingale First-to-default time Flight to quality Dependent mortality Universal variable life insurance Indifference pricing;

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    1. P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, 09.
    2. Fan Yu, 2007. "Correlated Defaults In Intensity-Based Models," Mathematical Finance, Wiley Blackwell, vol. 17(2), pages 155-173.
    3. Ludkovski, Michael & Young, Virginia R., 2008. "Indifference pricing of pure endowments and life annuities under stochastic hazard and interest rates," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 14-30, February.
    4. Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
    5. FFF1Tapani NNN1Valkonen & FFF2Pekka NNN2Martikainen & FFF2Jenni NNN2Blomgren, 2004. "Increasing excess mortality among non-married elderly people in developed countries," Demographic Research Special Collections, Max Planck Institute for Demographic Research, Rostock, Germany, vol. 2(12), pages 305-330, April.
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