Valuation of finance/insurance contracts: Efficient hedging and stochastic interest rates modeling

Article type: Research Article

Authors: Melnikov, Alexander^; | Tong, Shuo

Affiliations: Department of Mathematical and Statistical Science, University of Alberta, Edmonton, AB, Canada. E-mails: {melnikov, stong2}@ualberta.ca

Note: [] Corresponding author. Tel.: +1 780 4920568; E-mail: melnikov @ualberta.ca

Abstract: This paper studies the problem of hedging equity-linked life insurance contracts with efficient hedging technique in stochastic interest economy. In our setting, the payoff of life insurance contracts is based on two risky assets, where the return processes are driven by different correlated Wiener processes. The stochastic interest rate is assumed to follow the Heath–Jarrow–Morton framework. We obtain explicit formulas for both the price of a single premium contract and the corresponding survival probability. Moreover, a numerical example illustrates how this efficient hedging technique is applied to manage the balance between financial and insurance risks for a risk-taking insurance company.

Keywords: Efficient hedging, equity-linked life insurance, stochastic interest rate

DOI: 10.3233/RDA-130099

Journal: Risk and Decision Analysis, vol. 5, no. 1, pp. 23-41, 2014