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Valuing variable annuity guarantees with the multivariate Esscher transform

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  • Ng, Andrew Cheuk-Yin
  • Li, Johnny Siu-Hang
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    Abstract

    Variable annuities are usually sold with a range of guarantees that protect annuity holders from some downside market risk. Although it is common to see variable annuity guarantees written on multiple funds, existing pricing methods are, by and large, based on stochastic processes for one single asset only. In this article, we fill this gap by developing a multivariate valuation framework. First, we consider a multivariate regime-switching model for modeling returns on various assets at the same time. We then identify a risk-neutral probability measure for use with the model under consideration. This is accomplished by a multivariate extension of the regime-switching conditional Esscher transform. We further extend our results to the situation when the guarantee being valued is linked to equity indexes measured in foreign currencies. In particular, we derive a probability measure that is risk-neutral from the perspective of domestic investors. Finally, we illustrate our results with a hypothetical variable annuity guarantee.

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    Bibliographic Info

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

    Volume (Year): 49 (2011)
    Issue (Month): 3 ()
    Pages: 393-400

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    Handle: RePEc:eee:insuma:v:49:y:2011:i:3:p:393-400

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

    Related research

    Keywords: Minimum entropy; Incomplete market; Quanto; Regime-switching;

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    Cited by:
    1. Gan, Guojun, 2013. "Application of data clustering and machine learning in variable annuity valuation," Insurance: Mathematics and Economics, Elsevier, vol. 53(3), pages 795-801.
    2. Huang, H. & Milevsky, M.A. & Salisbury, T.S., 2014. "Optimal initiation of a GLWB in a variable annuity: No Arbitrage approach," Insurance: Mathematics and Economics, Elsevier, vol. 56(C), pages 102-111.
    3. Ng, Andrew C.Y. & Li, Johnny Siu-Hang & Chan, Wai-Sum, 2013. "Pricing options on stocks denominated in different currencies: Theory and illustrations," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 339-354.

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