Efficient hedging for equity-linked life insurance contracts with stochastic interest rate

Article type: Research Article

Authors: Melnikov, Alexander^; | Tong, Shuo

Affiliations: Department of Mathematics and Statistical Science, University of Alberta, Edmonton, AB, Canada

Note: [] Corresponding author: Alexander Melnikov, Department of Mathematics and Statistical Science, University of Alberta, Edmonton, AB, Canada T6G2G1. Tel.: +1 780 492 0568; Fax: +1 780 492 6826; E-mail: [email protected]

Abstract: This paper studies the problem of valuation equity-linked life insurance contracts with efficient hedging technique in a stochastic interest environment. In our setting, the payoff of such contracts is based on two risky assets governed by the Black–Scholes models: one is responsible for future gains, the other one is a stochastic guarantee. The behaviour of the stochastic interest rate is described by the Heath–Jarrow–Morton model. Explicit formulas for both the price of a single premium contract and the survival probability were derived respectively. A numerical example illustrates how a risk-taking insurance company may apply this efficient hedging technique to manage the balance between financial and insurance risks.

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

DOI: 10.3233/RDA-2012-0087

Journal: Risk and Decision Analysis, vol. 4, no. 3, pp. 207-223, 2013