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Variable annuities and the option to seek risk: Why should you diversify?

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  • Mahayni, Antje
  • Schneider, Judith C.

Abstract

We analyze the impacts of an additional rider incorporated in recent retirement products. The payoff is linked to the performance of a multi asset investment strategy and includes a minimum interest rate guarantee. In addition, the buyer receives the option to decide on the investments dynamically. Prominent examples are so called variable annuities. Due to the embedded guarantee, these products are interesting for risk averse investors who benefit from diversification. However, the price setting of the provider takes into account the most risky strategy. This implies that the investor mitigates optimally between the diversification and the worst case strategy. We analyze the distortion and utility effects caused by the additional rider in the presence of background risk and borrowing constraints. A simulation analysis sheds light on the question if the additional rider is worth its costs.

Suggested Citation

  • Mahayni, Antje & Schneider, Judith C., 2012. "Variable annuities and the option to seek risk: Why should you diversify?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2417-2428.
  • Handle: RePEc:eee:jbfina:v:36:y:2012:i:9:p:2417-2428
    DOI: 10.1016/j.jbankfin.2012.04.024
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    Cited by:

    1. Horneff, Vanya & Maurer, Raimond & Mitchell, Olivia S. & Rogalla, Ralph, 2015. "Optimal life cycle portfolio choice with variable annuities offering liquidity and investment downside protection," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 91-107.
    2. Steinorth, Petra & Mitchell, Olivia S., 2015. "Valuing variable annuities with guaranteed minimum lifetime withdrawal benefits," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 246-258.
    3. repec:bla:jrinsu:v:83:y:2016:i:4:p:979-1006 is not listed on IDEAS
    4. Thai Nguyen & Mitja Stadje, 2018. "Optimal investment for participating insurance contracts under VaR-Regulation," Papers 1805.09068, arXiv.org, revised May 2018.
    5. Antje Mahayni & Judith C. Schneider, 2016. "Minimum return guarantees, investment caps, and investment flexibility," Review of Derivatives Research, Springer, vol. 19(2), pages 85-111, July.

    More about this item

    Keywords

    Guaranteed accumulation benefits; Feasible contracts; Optimal portfolio choice; Non-market wealth; Utility losses;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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