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Evaluation of equity-linked products in the presence of policyholder surrender option using risk-control strategies

Published online by Cambridge University Press:  08 March 2021

Patrice Gaillardetz ,
Saeb Hachem  and
Mehran Moghtadai
Patrice Gaillardetz*
Affiliation:
Department of Mathematics, Statistics at Concordia University, Montreal, Canada
Mehran Moghtadai
Affiliation:
Innovation Department at TD Insurance, Montreal, Canada
*
*Corresponding author. E-mail: patrice.gaillardetz@concordia.ca
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Abstract

Throughout the past couple of decades, the surge in the sale of equity-linked products has led to many discussions on the evaluation and risk management of surrender options embedded in these products. However, most studies treat such options as American/Bermudian style options. In this article, a different approach is presented where only a portion of the policyholders react optimally due to the belief that not all policyholders are rational. Through this method, a probability of surrender is obtained based on the option moneyness and the product is partially hedged using local risk-control strategies. This partial hedging approach is versatile since few assumptions are required for the financial framework. To compare the different surrender assumptions, the initial capital requirement for an equity-linked product is obtained under a regime-switching equity model. Numerical examples illustrate the dynamics and efficiency of this hedging approach.

Keywords

Equity-linked productsRisk managementPartial hedgingLocal risk minimizing strategySurrender riskRegime switching equity model
Type
Original Research Paper
Information
Annals of Actuarial Science , Volume 16 , Issue 1 , March 2022 , pp. 25 - 41
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of Institute and Faculty of Actuaries

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