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Variance and Interest Rate Risk in Unit-Linked Insurance Policies

Author

Listed:
  • David Baños

    (Department of Mathematics, University of Oslo, PO Box 1053 Blindern, 0316 Oslo, Norway)

  • Marc Lagunas-Merino

    (Department of Mathematics, University of Oslo, PO Box 1053 Blindern, 0316 Oslo, Norway)

  • Salvador Ortiz-Latorre

    (Department of Mathematics, University of Oslo, PO Box 1053 Blindern, 0316 Oslo, Norway)

Abstract

One of the risks derived from selling long-term policies that any insurance company has arises from interest rates. In this paper, we consider a general class of stochastic volatility models written in forward variance form. We also deal with stochastic interest rates to obtain the risk-free price for unit-linked life insurance contracts, as well as providing a perfect hedging strategy by completing the market. We conclude with a simulation experiment, where we price unit-linked policies using Norwegian mortality rates. In addition, we compare prices for the classical Black-Scholes model against the Heston stochastic volatility model with a Vasicek interest rate model.

Suggested Citation

  • David Baños & Marc Lagunas-Merino & Salvador Ortiz-Latorre, 2020. "Variance and Interest Rate Risk in Unit-Linked Insurance Policies," Risks, MDPI, vol. 8(3), pages 1-23, August.
    • Handle: RePEc:gam:jrisks:v:8:y:2020:i:3:p:84-:d:395284
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    References listed on IDEAS

    as
    1. van Haastrecht, Alexander & Lord, Roger & Pelsser, Antoon & Schrager, David, 2009. "Pricing long-dated insurance contracts with stochastic interest rates and stochastic volatility," Insurance: Mathematics and Economics, Elsevier, vol. 45(3), pages 436-448, December.
    2. Marc Romano & Nizar Touzi, 1997. "Contingent Claims and Market Completeness in a Stochastic Volatility Model," Mathematical Finance, Wiley Blackwell, vol. 7(4), pages 399-412, October.
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    Cited by:

    1. Corina Constantinescu & Julia Eisenberg, 2021. "Special Issue “Interplay between Financial and Actuarial Mathematics”," Risks, MDPI, vol. 9(8), pages 1-3, July.
    2. David R. Ba~nos, 2020. "Life insurance policies with cash flows subject to random interest rate changes," Papers 2012.15541, arXiv.org.

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