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An identity of hitting times and its application to the valuation of guaranteed minimum withdrawal benefit

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  • Runhuan Feng
  • Hans W. Volkmer
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    Abstract

    In this paper we explore an identity in distribution of hitting times of a finite variation process (Yor's process) and a diffusion process (geometric Brownian motion with affine drift), which arise from various applications in financial mathematics. As a result, we provide analytical solutions to the fair charge of variable annuity guaranteed minimum withdrawal benefit (GMWB) from a policyholder's point of view, which was only previously obtained in the literature by numerical methods. We also use complex inversion methods to derive analytical solutions to the fair charge of the GMWB from an insurer's point of view, which is used in the market practice, however, based on Monte Carlo simulations. Despite of their seemingly different formulations, we can prove under certain assumptions the two pricing approaches are equivalent.

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    File URL: http://arxiv.org/pdf/1307.7070
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    Paper provided by arXiv.org in its series Papers with number 1307.7070.

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    Date of creation: Jul 2013
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    Handle: RePEc:arx:papers:1307.7070

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    1. M. Schr\"oder & P. Carr, 2003. "Bessel processes, the integral of geometric Brownian motion, and Asian options," Papers math/0311280, arXiv.org.
    2. Hélyette Geman & Marc Yor, 1993. "Bessel Processes, Asian Options, And Perpetuities," Mathematical Finance, Wiley Blackwell, vol. 3(4), pages 349-375.
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