Efficient Hedging And Pricing Of Equity-Linked Life Insurance Contracts On Several Risky Assets
AbstractThe paper uses the efficient hedging methodology in order to optimally price and hedge equity-linked life insurance contracts whose payoff depends on the performance of several risky assets. In particular, we consider a policy which pays the maximum of the values of n risky assets at some maturity date T, provided that the policyholder survives to T. Such contracts incorporate financial risk, which stems from the uncertainty about future prices of the underlying financial assets, and insurance risk, which arises from the policyholder's mortality. We show how efficient hedging can be used to minimize expected losses from imperfect hedging under a particular risk preference of the hedger. We also prove a probabilistic result, which allows one to calculate analytic pricing formulas for equity-linked payoffs with n risky assets. To illustrate its use, explicit formulas are given for optimal prices and expected hedging losses for payoffs with two risky assets. Numerical examples highlighting the implications of efficient hedging for the management of financial and insurance risks of equity-linked life insurance policies are also provided.
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Bibliographic InfoArticle provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.
Volume (Year): 11 (2008)
Issue (Month): 03 ()
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Other versions of this item:
- Alexander Melnikov & Yuliya Romanyuk, 2006. "Efficient Hedging and Pricing of Equity-Linked Life Insurance Contracts on Several Risky Assets," Working Papers 06-43, Bank of Canada.
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
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