Managing mortality risk with longevity bonds when mortality rates are cointegrated

Tat Wing WONG, Mei Choi CHIU, Hoi Ying WONG

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7 Citations (Scopus)

Abstract

This article investigates the dynamic mean-variance hedging problem of an insurer using longevity bonds (or longevity swaps). Insurance liabilities are modeled using a doubly stochastic compound Poisson process in which the mortality rate is correlated and cointegrated with the index mortality rate. We solve this dynamic hedging problem using a theory of forward–backward stochastic differential equations. Our theory shows that cointegration materially affects the optimal hedging strategy beyond correlation. The cointegration effect is independent of the risk preference of the insurer. Explicit solutions for the optimal hedging strategy are derived for cointegrated stochastic mortality models with both constant and state-dependent volatilities. Copyright © 2015 The Journal of Risk and Insurance.
Original languageEnglish
Pages (from-to)987-1023
JournalJournal of Risk and Insurance
Volume84
Issue number3
Early online dateOct 2015
DOIs
Publication statusPublished - 2017

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Cointegration
Mortality risk
Insurer
Hedging strategies
Mortality rate
Stochastic mortality
Liability insurance
Risk preferences
Swaps
Dynamic hedging
Stochastic differential equations
Compound Poisson process
Mean-variance hedging

Citation

Wong, T. W., Chiu, M. C., & Wong, H. Y. (2017). Managing mortality risk with longevity bonds when mortality rates are cointegrated. Journal of Risk and Insurance, 84(3), 987-1023.