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Valuation Of Guaranteed Annuity Options In Affine Term Structure Models

Author

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  • CHI CHIU CHU

    (Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China)

  • YUE KUEN KWOK

    (Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China)

Abstract

We propose three analytic approximation methods for numerical valuation of the guaranteed annuity options in deferred annuity pension policies. The approximation methods include the stochastic duration approach, Edgeworth expansion, and analytic approximation in affine diffusions. The payoff structure in the annuity policies is similar to a quanto call option written on a coupon-bearing bond. To circumvent the limitations of the one-factor interest rate model, we model the interest rate dynamics by a two-factor affine interest rate term structure model. The numerical accuracy and the computational efficiency of these approximation methods are analyzed. We also investigate the value sensitivity of the guaranteed annuity option with respect to different parameters in the pricing model.

Suggested Citation

  • Chi Chiu Chu & Yue Kuen Kwok, 2007. "Valuation Of Guaranteed Annuity Options In Affine Term Structure Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(02), pages 363-387.
  • Handle: RePEc:wsi:ijtafx:v:10:y:2007:i:02:n:s0219024907004160
    DOI: 10.1142/S0219024907004160
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    Citations

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    Cited by:

    1. van Haastrecht, Alexander & Plat, Richard & Pelsser, Antoon, 2010. "Valuation of guaranteed annuity options using a stochastic volatility model for equity prices," Insurance: Mathematics and Economics, Elsevier, vol. 47(3), pages 266-277, December.
    2. João Pedro Vidal Nunes & Pedro Miguel Silva Prazeres, 2014. "Pricing Swaptions Under Multifactor Gaussian Hjm Models," Mathematical Finance, Wiley Blackwell, vol. 24(4), pages 762-789, October.
    3. Gao, Huan & Mamon, Rogemar & Liu, Xiaoming & Tenyakov, Anton, 2015. "Mortality modelling with regime-switching for the valuation of a guaranteed annuity option," Insurance: Mathematics and Economics, Elsevier, vol. 63(C), pages 108-120.
    4. Roman Horsky & Tilman Sayer, 2015. "Joining The Heston And A Three-Factor Short Rate Model: A Closed-Form Approach," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(08), pages 1-17, December.
    5. Deelstra, Griselda & Rayée, Grégory, 2013. "Pricing Variable Annuity Guarantees in a local volatility framework," Insurance: Mathematics and Economics, Elsevier, vol. 53(3), pages 650-663.
    6. 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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