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Bilateral Trade, Openness and Asset Holdings

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Author Info

  • Jing Li

    ()

  • Alexander Szimayer

    ()

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    Abstract

    We study the valuation of unit-linked life insurance contracts with surrender guarantees. Instead of solving an optimal stopping problem, we propose a more realistic approach accounting for policyholders’ rationality in exercising their surrender option. The valuation is conducted at the portfolio level by assuming the surrender intensity to be bounded from below and from above. The lower bound corresponds to purely exogenous surrender and the upper bound represents the limited rationality of the policyholders. The valuation problem is formulated by a valuation PDE and solved with the finite difference method. We show that the rationality of the policyholders has a significant effect on average contract value and hence on the fair contract design. We also present the separating boundary between purely exogenous surrender and endogenous surrender. This provides implications on the predicted surrender activity of the policyholders.

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    File URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonedp/bgse22_2010.pdf
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    Bibliographic Info

    Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse22_2010.

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    Length: 22
    Date of creation: Dec 2010
    Date of revision:
    Handle: RePEc:bon:bonedp:bgse22_2010

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    Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
    Fax: +49 228 73 6884
    Web page: http://www.bgse.uni-bonn.de

    Related research

    Keywords: unit-linked life insurance contracts; surrender guarantee; limited rationality; fair contract analysis;

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