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DYNAMIC HEDGING OF LONGEVITY RISK: THE EFFECT OF TRADING FREQUENCY

Published online by Cambridge University Press:  31 August 2017

Hong Li
Hong Li*
Affiliation:
School of Finance, Nankai University, Tongyan Road 38, 300350, Tianjin, P.R.China
*
E-Mail: hong.li@nankai.edu.cn
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Abstract

This paper investigates dynamic hedging strategies for pension and annuity liabilities that are exposed to longevity risk. In particular, we consider a hedger who wishes to minimize the variance of her hedging error using index-based longevity-linked derivatives. To cope with the fact that liquidity of longevity-linked derivatives is still limited, we consider a liquidity constrained case where the hedger can only trade longevity-linked derivatives at a frequency lower than other assets. Time-consistent, closed-form solutions of optimal hedging strategies are obtained under a forward mortality framework. In the numerical illustration, we show that lowering the trading of the longevity-linked derivatives to a 2-year frequency only leads to a slight loss of the hedging performance. Moreover, even when the longevity-linked derivatives are traded at a very low (5-year) frequency, dynamic hedging strategies still significantly outperform the static one.

Keywords

Dynamic hedginglongevity riskminimum varianceforward mortality model
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 48 , Issue 1 , January 2018 , pp. 197 - 232
Copyright
Copyright © Astin Bulletin 2017 

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