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On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics

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  • Denis-Alexandre Trottier

    (Faculté des Sciences de l’Administration, Université Laval, Québec, QC G1V 0A6, Canada)

  • Frédéric Godin

    (Department of Mathematics and Statistics, Concordia University, Montréal, QC H3G 1M8, Canada
    École d’Actuariat, Université Laval, Québec, QC G1V 0A6, Canada)

  • Emmanuel Hamel

    (École d’Actuariat, Université Laval, Québec, QC G1V 0A6, Canada)

Abstract

Insurers issuing segregated fund policies apply dynamic hedging to mitigate risks related to guarantees embedded in such policies. A typical industry practice consists of using fund mapping regressions to represent basis risk stemming from the imperfect correlation between the underlying fund and its corresponding hedging instruments. The current work discusses the implications of using fund mapping regressions when the joint dynamics of the underlying and hedging assets is a regime-switching process. The potential underestimation of capital requirements stemming from the use of a fund mapping regression under such dynamics is discussed. The magnitude of the latter phenomenon is quantified through simulations calibrated on market data.

Suggested Citation

  • Denis-Alexandre Trottier & Frédéric Godin & Emmanuel Hamel, 2018. "On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics," Risks, MDPI, vol. 6(3), pages 1-15, August.
    • Handle: RePEc:gam:jrisks:v:6:y:2018:i:3:p:78-:d:162962
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    References listed on IDEAS

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    1. Parsiad Azimzadeh & Peter A. Forsyth & Kenneth R. Vetzal, 2014. "Hedging Costs for Variable Annuities Under Regime-Switching," International Series in Operations Research & Management Science, in: Rogemar S. Mamon & Robert J. Elliott (ed.), Hidden Markov Models in Finance, edition 127, chapter 0, pages 133-166, Springer.
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    5. Trottier, Denis-Alexandre & Godin, Frédéric & Hamel, Emmanuel, 2018. "Local Hedging Of Variable Annuities In The Presence Of Basis Risk," ASTIN Bulletin, Cambridge University Press, vol. 48(2), pages 611-646, May.
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    Cited by:

    1. Carbonneau, Alexandre, 2021. "Deep hedging of long-term financial derivatives," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 327-340.
    2. Alexandre Carbonneau, 2020. "Deep Hedging of Long-Term Financial Derivatives," Papers 2007.15128, arXiv.org.
    3. Godin, Frédéric & Lai, Van Son & Trottier, Denis-Alexandre, 2019. "Option pricing under regime-switching models: Novel approaches removing path-dependence," Insurance: Mathematics and Economics, Elsevier, vol. 87(C), pages 130-142.

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