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LOCAL HEDGING OF VARIABLE ANNUITIES IN THE PRESENCE OF BASIS RISK

Published online by Cambridge University Press:  25 April 2018

Denis-Alexandre Trottier ,
Frédéric Godin  and
Emmanuel Hamel
Denis-Alexandre Trottier
Affiliation:
Université Laval, Faculté des Sciences de l'Administration, Québec, Canada E-Mail: [email protected]
Frédéric Godin*
Affiliation:
Concordia University, Department of Mathematics and Statistics, Montréal, Québec, Canada, Université Laval, École d'Actuariat, Québec, Canada
Emmanuel Hamel
Affiliation:
Université Laval, École d'Actuariat, Québec, Canada E-Mail: [email protected]
*
E-Mail: [email protected]
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Abstract

A method to hedge variable annuities in the presence of basis risk is developed. A regime-switching model is considered for the dynamics of market assets. The approach is based on a local optimization of risk and is therefore very tractable and flexible. The local optimization criterion is itself optimized to minimize capital requirements associated with the variable annuity policy, the latter being quantified by the Conditional Value-at-Risk (CVaR) risk metric. In comparison to benchmarks, our method is successful in simultaneously reducing capital requirements and increasing profitability. Indeed the proposed local hedging scheme benefits from a higher exposure to equity risk and from time diversification of risk to earn excess return and facilitate the accumulation of capital. A robust version of the hedging strategies addressing model risk and parameter uncertainty is also provided.

Keywords

Basis riskhedgingsegregated fundsvariable annuitiesrisk measuresrisk managementregime-switching modelsG22G31G32C61
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 48 , Issue 2 , May 2018 , pp. 611 - 646
Copyright
Copyright © Astin Bulletin 2018 

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