Mean–variance asset–liability management: Cointegrated assets and insurance liability

Mei Choi CHIU, Hoi Ying WONG

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35 Citations (Scopus)

Abstract

The cointegration of major financial markets around the globe is well evidenced with strong empirical support. This paper considers the continuous-time mean–variance (MV) asset–liability management (ALM) problem for an insurer investing in an incomplete financial market with cointegrated assets. The number of trading assets is allowed to be less than the number of Brownian motions spanning the market. The insurer also faces the risk of paying uncertain insurance claims during the investment period. We assume that the cointegration market follows the diffusion limit of the error-correction model for cointegrated time series. Using the Markowitz (1952) MV portfolio criterion, we consider the insurer’s problem of minimizing variance in the terminal wealth, given an expected terminal wealth subject to interim random liability payments following a compound Poisson process. We generalize the technique developed by Lim (2005) to tackle this problem. The particular structure of cointegration enables us to solve the ALM problem completely in the sense that the solutions of the continuous-time portfolio policy and efficient frontier are obtained as explicit and closed-form formulas. Copyright © 2012 Elsevier B. V. All rights reserved.
Original languageEnglish
Pages (from-to)785-793
JournalEuropean Journal of Operational Research
Volume223
Issue number3
DOIs
Publication statusPublished - Dec 2012

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Asset Management
Asset management
Insurance
Cointegration
Brownian movement
Error correction
Financial Markets
Continuous Time
Time series
Error Correction Model
Diffusion Limit
Efficient Frontier
Compound Poisson Process
Incomplete Markets
Globe
Brownian motion
Closed-form
Generalise
Financial markets
Liability insurance

Citation

Chiu, M. C., & Wong, H. Y. (2012). Mean–variance asset–liability management: Cointegrated assets and insurance liability. European Journal of Operational Research, 223(3), 785-793.

Keywords

  • Asset–liability management
  • Cointegration
  • Mean–variance portfolio theory