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A binomial model for valuing equity-linked policies embedding surrender options

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  • Costabile, Massimo
  • Massabó, Ivar
  • Russo, Emilio

Abstract

The computation of the fair periodical premiums for equity-linked policies in a Cox-Ross-Rubinstein (CRR)Â [Cox, J.C., et al., 1979. Option pricing: A simplified approach. J. Financial Economics 7, 229-263] evaluation framework is computationally complex. In fact, despite we assume that the equity value evolves according to a CRR lattice, the dynamics of the reference fund made up of equities of the same kind is described by a non-recombining tree since, at each contribution date, a constant contribution is added to the fund value. We propose to overcome this problem by selecting representative values among all the effective reference fund values. Then, the fair periodical premiums for equity-linked policies embedding a surrender option and a minimum guarantee are computed following the usual backward-induction scheme coupled with linear interpolation.

Suggested Citation

  • Costabile, Massimo & Massabó, Ivar & Russo, Emilio, 2008. "A binomial model for valuing equity-linked policies embedding surrender options," Insurance: Mathematics and Economics, Elsevier, vol. 42(3), pages 873-886, June.
  • Handle: RePEc:eee:insuma:v:42:y:2008:i:3:p:873-886
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    References listed on IDEAS

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    1. Bacinello, Anna Rita, 2005. "Endogenous model of surrender conditions in equity-linked life insurance," Insurance: Mathematics and Economics, Elsevier, pages 270-296.
    2. 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.
    3. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. Yang, Sharon S. & Dai, Tian-Shyr, 2013. "A flexible tree for evaluating guaranteed minimum withdrawal benefits under deferred life annuity contracts with various provisions," Insurance: Mathematics and Economics, Elsevier, pages 231-242.
    2. Shen, Yang & Sherris, Michael & Ziveyi, Jonathan, 2016. "Valuation of guaranteed minimum maturity benefits in variable annuities with surrender options," Insurance: Mathematics and Economics, Elsevier, pages 127-137.
    3. Costabile, Massimo & Gaudenzi, Marcellino & Massabò, Ivar & Zanette, Antonino, 2009. "Evaluating fair premiums of equity-linked policies with surrender option in a bivariate model," Insurance: Mathematics and Economics, Elsevier, vol. 45(2), pages 286-295, October.
    4. Dai, Tian-Shyr & Yang, Sharon S. & Liu, Liang-Chih, 2015. "Pricing guaranteed minimum/lifetime withdrawal benefits with various provisions under investment, interest rate and mortality risks," Insurance: Mathematics and Economics, Elsevier, pages 364-379.
    5. Kevin Fergusson & Eckhard Platen, 2013. "Real World Pricing of Long Term Cash-Linked Annuities and Equity-Linked Annuities with Cash-Linked Guarantees," Research Paper Series 338, Quantitative Finance Research Centre, University of Technology, Sydney.
    6. Russo, Vincenzo & Giacometti, Rosella & Fabozzi, Frank J., 2017. "Intensity-based framework for surrender modeling in life insurance," Insurance: Mathematics and Economics, Elsevier, pages 189-196.
    7. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.
    8. Su, Karen C., 2010. "The conversion option in life insurance," Insurance: Mathematics and Economics, Elsevier, vol. 46(3), pages 437-442, June.
    9. Gan, Guojun, 2013. "Application of data clustering and machine learning in variable annuity valuation," Insurance: Mathematics and Economics, Elsevier, pages 795-801.

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