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Using bootstrapping to incorporate model error for risk-neutral pricing of longevity risk

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  • Yang, Bowen
  • Li, Jackie
  • Balasooriya, Uditha

Abstract

Where mortality projection is concerned, it is essential to quantify the extent of the prediction error. This is especially important in light of the aggravating risk of longevity and as a result the increasing demand for longevity-linked products. In the literature so far, only parameter error and process error have been considered jointly while the issue of model error has yet been systematically studied. In this paper, we propose a method to account for process error, parameter error and model error in an integrated manner by modifying the semi-parametric bootstrapping technique. We apply the method to two data sets from the Continuous Mortality Investigation (CMI) and use the simulated scenarios to price the q-forward contracts via the maximum entropy approach. We find that model selection has a significant impact on the risk-neutral valuation results and thus it is crucial to incorporate model error in mortality projection.

Suggested Citation

  • Yang, Bowen & Li, Jackie & Balasooriya, Uditha, 2015. "Using bootstrapping to incorporate model error for risk-neutral pricing of longevity risk," Insurance: Mathematics and Economics, Elsevier, vol. 62(C), pages 16-27.
    • Handle: RePEc:eee:insuma:v:62:y:2015:i:c:p:16-27
    DOI: 10.1016/j.insmatheco.2015.02.004
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    References listed on IDEAS

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    4. Uditha Balasooriya & Johnny Siu-Hang Li & Jackie Li, 2020. "The Impact of Model Uncertainty on Index-Based Longevity Hedging and Measurement of Longevity Basis Risk," Risks, MDPI, vol. 8(3), pages 1-27, August.
    5. Feng, Ben Mingbin & Li, Johnny Siu-Hang & Zhou, Kenneth Q., 2022. "Green nested simulation via likelihood ratio: Applications to longevity risk management," Insurance: Mathematics and Economics, Elsevier, vol. 106(C), pages 285-301.

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