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Quantile hedging and its application to life insurance

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  • Melnikov Alexander
  • Skornyakova Victoria

Abstract

The paper develops the method of quantile hedging in a two-factor jump-diffusion market. The exact formulae of the maximal successful hedging set for an option to exchange one asset for another are given. These results are applied to a class of equity-linked life insurance contracts called “pure endowments with a guarantee”. In our setting, the pay-off functions of these insurance contracts are equal to the maximum of two risky assets in a two-factor jump-diffusion model conditioned by the survival status of the insured. The first asset is responsible for the maximal size of future profits, while the second provides a flexible guarantee to the insured. Based on quantile hedging methodology and a generalized Margrabe's formula, the paper describes the valuation and risk management of such mixed finance-insurance instruments.

Suggested Citation

  • Melnikov Alexander & Skornyakova Victoria, 2005. "Quantile hedging and its application to life insurance," Statistics & Risk Modeling, De Gruyter, vol. 23(4), pages 301-316, April.
    • Handle: RePEc:bpj:strimo:v:23:y:2005:i:4/2005:p:301-316:n:3
    DOI: 10.1524/stnd.2005.23.4.301
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    References listed on IDEAS

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    1. Brennan, Michael J. & Schwartz, Eduardo S., 1976. "The pricing of equity-linked life insurance policies with an asset value guarantee," Journal of Financial Economics, Elsevier, vol. 3(3), pages 195-213, June.
    2. Brennan, Michael J & Schwartz, Eduardo S, 1979. "Alternative Investment Strategies for the Issuers of Equity Linked Life Insurance Policies with an Asset Value Guarantee," The Journal of Business, University of Chicago Press, vol. 52(1), pages 63-93, January.
    3. Steinar Ekern & Svein-Arne Persson, 1996. "Exotic Unit-Linked Life Insurance Contracts," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 21(1), pages 35-63, June.
    4. Bacinello, Anna Rita, 2001. "Fair Pricing of Life Insurance Participating Policies with a Minimum Interest Rate Guaranteed," ASTIN Bulletin, Cambridge University Press, vol. 31(2), pages 275-297, November.
    5. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    6. Hans FÃllmer & Peter Leukert, 1999. "Quantile hedging," Finance and Stochastics, Springer, vol. 3(3), pages 251-273.
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    Citations

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    Cited by:

    1. Klusik, Przemyslaw & Palmowski, Zbigniew, 2011. "Quantile hedging for equity-linked contracts," Insurance: Mathematics and Economics, Elsevier, vol. 48(2), pages 280-286, March.
    2. Melnikov, Alexander & Smirnov, Ivan, 2012. "Dynamic hedging of conditional value-at-risk," Insurance: Mathematics and Economics, Elsevier, vol. 51(1), pages 182-190.
    3. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.

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