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Evaluation of credit value adjustment in K-forward

Author

Listed:
  • Hao, Xuemiao
  • Liang, Chunli
  • Wei, Linghua

Abstract

We model and quantify counterparty credit risk for K-forward, a newly proposed longevity-linked security. We focus on the evaluation of credit value adjustment (CVA) from the longevity risk hedger’s perspective. The modelling involves two folds. First, we use a vector autoregressive integrated moving-average process to model the time series of mortality indexes that is obtained by applying the original Cairns–Blake–Dowd model. Then, the risk-neutral default probability of the hedge provider is obtained by calibrating a reduced-form default model on the market price of bonds issued by the hedge provider. We calculate and compare CVA in K-forwards for different combinations of hedger provider, reference year and recovery rate.

Suggested Citation

  • Hao, Xuemiao & Liang, Chunli & Wei, Linghua, 2017. "Evaluation of credit value adjustment in K-forward," Insurance: Mathematics and Economics, Elsevier, vol. 76(C), pages 95-103.
    • Handle: RePEc:eee:insuma:v:76:y:2017:i:c:p:95-103
    DOI: 10.1016/j.insmatheco.2017.07.004
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    References listed on IDEAS

    as
    1. Cairns, Andrew J.G. & Blake, David & Dowd, Kevin & Coughlan, Guy D. & Epstein, David & Khalaf-Allah, Marwa, 2011. "Mortality density forecasts: An analysis of six stochastic mortality models," Insurance: Mathematics and Economics, Elsevier, vol. 48(3), pages 355-367, May.
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    3. David Blake & Andrew Cairns & Guy Coughlan & Kevin Dowd & Richard MacMinn, 2013. "The New Life Market," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 80(3), pages 501-558, September.
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    6. Wai-Sum Chan & Johnny Li & Jackie Li, 2014. "The CBD Mortality Indexes: Modeling and Applications," North American Actuarial Journal, Taylor & Francis Journals, vol. 18(1), pages 38-58.
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    9. Tan, Chong It & Li, Jackie & Li, Johnny Siu-Hang & Balasooriya, Uditha, 2014. "Parametric mortality indexes: From index construction to hedging strategies," Insurance: Mathematics and Economics, Elsevier, vol. 59(C), pages 285-299.
    10. Andrew J. G. Cairns & David Blake & Kevin Dowd, 2006. "A Two‐Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 687-718, December.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Credit value adjustment; K-forward; Longevity risk; Multivariate time series; Risk-neutral default probability;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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