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Calculating Variable Annuity Liability 'Greeks' Using Monte Carlo Simulation

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  • Mark J. Cathcart
  • Steven Morrison
  • Alexander J. McNeil
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    Abstract

    Hedging methods to mitigate the exposure of variable annuity products to market risks require the calculation of market risk sensitivities (or "Greeks"). The complex, path-dependent nature of these products means these sensitivities typically must be estimated by Monte Carlo simulation. Standard market practice is to measure such sensitivities using a "bump and revalue" method. As well as requiring multiple valuations, such approaches can be unreliable for higher order Greeks, e.g., gamma. In this article we investigate alternative estimators implemented within an advanced economic scenario generator model, incorporating stochastic interest-rates and stochastic equity volatility. The estimators can also be easily generalized to work with the addition of equity jumps in this model.

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    File URL: http://arxiv.org/pdf/1110.4516
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    Paper provided by arXiv.org in its series Papers with number 1110.4516.

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    Date of creation: Oct 2011
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    Handle: RePEc:arx:papers:1110.4516

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    1. Mark Broadie & Paul Glasserman, 1996. "Estimating Security Price Derivatives Using Simulation," Management Science, INFORMS, vol. 42(2), pages 269-285, February.
    2. Rajan Suri & Michael A. Zazanis, 1988. "Perturbation Analysis Gives Strongly Consistent Sensitivity Estimates for the M/G/1 Queue," Management Science, INFORMS, vol. 34(1), pages 39-64, January.
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