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A Two-Population Mortality Model to Assess Longevity Basis Risk

Author

Listed:
  • Selin Özen

    (Department of Actuarial Sciences and Risk Management, Karabük University, 78050 Karabük, Turkey
    These authors contributed equally to this work.)

  • Şule Şahin

    (Department of Mathematical Sciences, Institute for Financial and Actuarial Mathematics, University of Liverpool, Liverpool L69 3BX, UK
    These authors contributed equally to this work.)

Abstract

Index-based hedging solutions are used to transfer the longevity risk to the capital markets. However, mismatches between the liability of the hedger and the hedging instrument cause longevity basis risk. Therefore, an appropriate two-population model to measure and assess longevity basis risk is required. In this paper, we aim to construct a two-population mortality model to provide an effective hedge against the basis risk. The reference population is modelled by using the Lee–Carter model with the renewal process and exponential jumps, and the dynamics of the book population are specified. The analysis based on the U.K. mortality data indicate that the proposed model for the reference population and the common age effect model for the book population provide a better fit compared to the other models considered in the paper. Different two-population models are used to investigate the impact of sampling risk on the index-based hedge, as well as to analyse the risk reduction regarding hedge effectiveness. The results show that the proposed model provides a significant risk reduction when mortality jumps and sampling risk are taken into account.

Suggested Citation

  • Selin Özen & Şule Şahin, 2021. "A Two-Population Mortality Model to Assess Longevity Basis Risk," Risks, MDPI, vol. 9(2), pages 1-19, February.
    • Handle: RePEc:gam:jrisks:v:9:y:2021:i:2:p:44-:d:502894
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    References listed on IDEAS

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    1. Corina Constantinescu & Julia Eisenberg, 2021. "Special Issue “Interplay between Financial and Actuarial Mathematics”," Risks, MDPI, vol. 9(8), pages 1-3, July.

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