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The existence of optimal bang-bang controls for GMxB contracts

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  • Parsiad Azimzadeh
  • Peter A. Forsyth

Abstract

A large collection of financial contracts offering guaranteed minimum benefits are often posed as control problems, in which at any point in the solution domain, a control is able to take any one of an uncountable number of values from the admissible set. Often, such contracts specify that the holder exert control at a finite number of deterministic times. The existence of an optimal bang-bang control, an optimal control taking on only a finite subset of values from the admissible set, is a common assumption in the literature. In this case, the numerical complexity of searching for an optimal control is considerably reduced. However, no rigorous treatment as to when an optimal bang-bang control exists is present in the literature. We provide the reader with a bang-bang principle from which the existence of such a control can be established for contracts satisfying some simple conditions. The bang-bang principle relies on the convexity and monotonicity of the solution and is developed using basic results in convex analysis and parabolic partial differential equations. We show that a guaranteed lifelong withdrawal benefit (GLWB) contract admits an optimal bang-bang control. In particular, we find that the holder of a GLWB can maximize a writer's losses by only ever performing nonwithdrawal, withdrawal at exactly the contract rate, or full surrender. We demonstrate that the related guaranteed minimum withdrawal benefit contract is not convexity preserving, and hence does not satisfy the bang-bang principle other than in certain degenerate cases.

Suggested Citation

  • Parsiad Azimzadeh & Peter A. Forsyth, 2015. "The existence of optimal bang-bang controls for GMxB contracts," Papers 1502.05743, arXiv.org, revised Nov 2015.
    • Handle: RePEc:arx:papers:1502.05743
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    References listed on IDEAS

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    Cited by:

    1. Parsiad Azimzadeh & Peter A. Forsyth, 2015. "Weakly chained matrices, policy iteration, and impulse control," Papers 1510.03928, arXiv.org, revised Sep 2017.
    2. Seyed Amir Hejazi & Kenneth R. Jackson, 2016. "A Neural Network Approach to Efficient Valuation of Large Portfolios of Variable Annuities," Papers 1606.07831, arXiv.org.
    3. Zhiyi Shen, 2022. "Out-of-Model Adjustments of Variable Annuities," Papers 2208.12838, arXiv.org.
    4. Fontana, Claudio & Rotondi, Francesco, 2023. "Valuation of general GMWB annuities in a low interest rate environment," Insurance: Mathematics and Economics, Elsevier, vol. 112(C), pages 142-167.
    5. Kirkby, J. Lars & Nguyen, Duy, 2021. "Equity-linked Guaranteed Minimum Death Benefits with dollar cost averaging," Insurance: Mathematics and Economics, Elsevier, vol. 100(C), pages 408-428.
    6. Hejazi, Seyed Amir & Jackson, Kenneth R., 2016. "A neural network approach to efficient valuation of large portfolios of variable annuities," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 169-181.
    7. Yaowen Lu & Duy-Minh Dang, 2023. "A semi-Lagrangian $\epsilon$-monotone Fourier method for continuous withdrawal GMWBs under jump-diffusion with stochastic interest rate," Papers 2310.00606, arXiv.org.
    8. Zhiyi Shen & Chengguo Weng, 2019. "A Backward Simulation Method for Stochastic Optimal Control Problems," Papers 1901.06715, arXiv.org.
    9. Yao Tung Huang & Yue Kuen Kwok, 2016. "Regression-based Monte Carlo methods for stochastic control models: variable annuities with lifelong guarantees," Quantitative Finance, Taylor & Francis Journals, vol. 16(6), pages 905-928, June.
    10. Jin Sun & Pavel V. Shevchenko & Man Chung Fung, 2018. "The Impact of Management Fees on the Pricing of Variable Annuity Guarantees," Risks, MDPI, vol. 6(3), pages 1-20, September.
    11. Claudio Fontana & Francesco Rotondi, 2022. "Valuation of general GMWB annuities in a low interest rate environment," Papers 2208.10183, arXiv.org, revised Aug 2023.
    12. Pavel V. Shevchenko & Xiaolin Luo, 2016. "A Unified Pricing of Variable Annuity Guarantees under the Optimal Stochastic Control Framework," Risks, MDPI, vol. 4(3), pages 1-31, July.

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