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A Multivariate Model of Strategic Asset Allocation with Longevity Risk

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  • Emilio Bisetti
  • Carlo A. Favero
  • Giacomo Nocera
  • Claudio Tebaldi

Abstract

This paper proposes a framework to evaluate the impact of longevity-linked securities on the risk-return trade-off for traditional portfolios. Generalized unexpected raise in life expectancy is a source of aggregate risk in the insurance sector balance sheets. Longevity-linked securities are a natural instrument to reallocate these risks by making them tradable in the financial market. This paper extends the strategic asset allocation model of (Campbell Viceira 2005) to include a longevity-linked investment in addition to equity and fixed income securities and describe the resulting term structure of risk-return trade-offs. The model highlights an unexpected predictability pattern of the survival probability estimates and gives an empirical valuation of the market price of longevity risk based on the LeeCarter(1992) mortality model and on the time series of prices for standardized annuities publicly offered by US insurance companies. Keywords: Longevity Risk, Strategic Asset Allocation JEL Classification: [G11, G12, G22]

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Bibliographic Info

Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 503.

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Date of creation: 2013
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Handle: RePEc:igi:igierp:503

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  1. Erhan Bayraktar & Virginia R. Young, 2007. "Pricing Options in Incomplete Equity Markets via the Instantaneous Sharpe Ratio," Papers math/0701650, arXiv.org, revised Jul 2007.
  2. Campbell, John Y. & Lo, Andrew W. & MacKinlay, A. Craig & Whitelaw, Robert F., 1998. "The Econometrics Of Financial Markets," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 2(04), pages 559-562, December.
  3. John Y. Campbell, 1995. "Understanding Risk and Return," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1711, Harvard - Institute of Economic Research.
  4. Biffis, Enrico & Blake, David, 2010. "Securitizing and tranching longevity exposures," Insurance: Mathematics and Economics, Elsevier, vol. 46(1), pages 186-197, February.
  5. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  6. Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, American Finance Association, vol. 55(1), pages 225-264, 02.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Olivia S. Mitchell & James M. Poterba & Mark J. Warshawsky, . "New Evidence on the Money's Worth of Individual Annuities," Pension Research Council Working Papers, Wharton School Pension Research Council, University of Pennsylvania 97-9, Wharton School Pension Research Council, University of Pennsylvania.
  9. Erhan Bayraktar & Moshe Milevsky & David Promislow & Virginia Young, 2008. "Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Life Annuities," Papers 0802.3250, arXiv.org.
  10. Pitacco, Ermanno & Denuit, Michel & Haberman, Steven & Olivieri, Annamaria, 2009. "Modelling Longevity Dynamics for Pensions and Annuity Business," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780199547272, October.
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