Pricing Longevity Bonds Using Affine-Jump Diffusion Models
Historically, actuaries have been calculating premiums and mathematical reserves using a deterministic approach, by considering a deterministic mortality intensity, which is a function of the age only, extracted from available (static) life tables and by setting a flat ("best estimate") interest rate to discount cash flows over time. Since neither the mortality intensity nor interest rates are actually deterministic, life insurance companies and pension funds are exposed to both financial and mortality (systematic and unsystematic) risks when pricing and reserving for any kind of long-term living benefits, particularly on annuities and pensions. In this paper, we assume that an appropriate description of the demographic risks requires the use of stochastic models. In particular, we assume that the random evolution of the stochastic force of mortality of an individual can be modelled by using doubly stochastic processes. The model is then embedded into the well known affine-jump framework, widely used in the term structure literature, in order to derive closed-form solutions for the survival probability. We show that stochastic mortality models provide an adequate framework for the development of longevity risk hedging tools, namely mortality-linked contracts such as longevity bonds or mortality derivatives.
|Date of creation:||2011|
|Date of revision:|
|Contact details of provider:|| Postal: Colégio Espírito SANTO|
Phone: (351) 266 740 869
Web page: http://www.cefage.uevora.pt
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Renshaw, A. E. & Haberman, S., 2003. "On the forecasting of mortality reduction factors," Insurance: Mathematics and Economics, Elsevier, vol. 32(3), pages 379-401, July.
- Andrew J. G. Cairns & David Blake & Kevin Dowd, 2006. "A Two-Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 687-718.
- Philippe Artzner & Freddy Delbaen, 1995. "Default Risk Insurance And Incomplete Markets," Mathematical Finance, Wiley Blackwell, vol. 5(3), pages 187-195.
- 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.
- Lawrence R. Carter & Alexia Prskawetz, 2001. "Examining structural shifts in mortality using the Lee-Carter method," MPIDR Working Papers WP-2001-007, Max Planck Institute for Demographic Research, Rostock, Germany.
- Cairns, Andrew J.G. & Blake, David & Dowd, Kevin, 2006. "Pricing Death: Frameworks for the Valuation and Securitization of Mortality Risk," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 36(01), pages 79-120, May.
- Shripad Tuljapurkar & Carl Boe, . "Mortality Change and Forecasting: How Much and How Little Do We Know?," Pension Research Council Working Papers 98-2, Wharton School Pension Research Council, University of Pennsylvania.
- L. C. G. Rogers, 1997. "The Potential Approach to the Term Structure of Interest Rates and Foreign Exchange Rates," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 157-176.
- Milevsky, Moshe A. & David Promislow, S., 2001. "Mortality derivatives and the option to annuitise," Insurance: Mathematics and Economics, Elsevier, vol. 29(3), pages 299-318, December.
- Pitacco, Ermanno, 2004. "Survival models in a dynamic context: a survey," Insurance: Mathematics and Economics, Elsevier, vol. 35(2), pages 279-298, October.
- Ballotta, Laura & Haberman, Steven, 2006. "The fair valuation problem of guaranteed annuity options: The stochastic mortality environment case," Insurance: Mathematics and Economics, Elsevier, vol. 38(1), pages 195-214, February.
- Brouhns, Natacha & Denuit, Michel & Vermunt, Jeroen K., 2002. "A Poisson log-bilinear regression approach to the construction of projected lifetables," Insurance: Mathematics and Economics, Elsevier, vol. 31(3), pages 373-393, December.
- Piet De Jong & Leonie Tickle, 2006. "Extending Lee-Carter Mortality Forecasting," Mathematical Population Studies, Taylor & Francis Journals, vol. 13(1), pages 1-18.
When requesting a correction, please mention this item's handle: RePEc:cfe:wpcefa:2011_29. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Angela Pacheco)
If references are entirely missing, you can add them using this form.