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Financial Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Pricing Pure Endowments

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  • Moshe A. Milevsky
  • S. David Promislow
  • Virginia R. Young

Abstract

We develop a theory for pricing non-diversifiable mortality risk in an incomplete market. We do this by assuming that the company issuing a mortality-contingent claim requires compensation for this risk in the form of a pre-specified instantaneous Sharpe ratio. We prove that our ensuing valuation formula satisfies a number of desirable properties. For example, we show that it is subadditive in the number of contracts sold. A key result is that if the hazard rate is stochastic, then the risk-adjusted survival probability is greater than the physical survival probability, even as the number of contracts approaches infinity.

Suggested Citation

  • Moshe A. Milevsky & S. David Promislow & Virginia R. Young, 2007. "Financial Valuation of Mortality Risk via the Instantaneous Sharpe Ratio: Applications to Pricing Pure Endowments," Papers 0705.1302, arXiv.org.
    • Handle: RePEc:arx:papers:0705.1302
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    References listed on IDEAS

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    1. Blanchet-Scalliet, Christophette & El Karoui, Nicole & Martellini, Lionel, 2005. "Dynamic asset pricing theory with uncertain time-horizon," Journal of Economic Dynamics and Control, Elsevier, vol. 29(10), pages 1737-1764, October.
    2. Dahl, Mikkel, 2004. "Stochastic mortality in life insurance: market reserves and mortality-linked insurance contracts," Insurance: Mathematics and Economics, Elsevier, vol. 35(1), pages 113-136, August.
    3. Boyle, Phelim & Hardy, Mary, 2003. "Guaranteed Annuity Options," ASTIN Bulletin, Cambridge University Press, vol. 33(2), pages 125-152, November.
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