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Imperfect Hedging on Equity-Linked Life Insurance with Market Constraints: Stochastic Interest Rate and Transaction Costs

  • Author / Creator
    Tong, Shuo
  • Equity-linked life insurance contracts are a type of investment product issued by insurance companies to provide the insured with more appealing benefits, compared with the traditional insurance policy. Such benefits are not only linked to the performance of the underlying investments in the financial market, but also related with some insurance type events, such as death and survival to the contract maturity. Therefore, the equity-linked life insurance contract includes both the financial risk generated from the performance of the risky assets and the insurance risk reflected by the policyholders’ survival probability. In this thesis, we consider the problem of utilizing imperfect hedging techniques to value equity-linked life insurance contract with market restrictions: stochastic interest rate and transaction costs. We employ two powerful imperfect hedging techniques to investigate the problem – quantile hedging and efficient hedging. We show that they are effective tools for managing both financial and insurance risk inherent in equity-linked life insurance contracts in a stochastic interest rate economy. Moreover, we incorporate transaction costs in the analysis of quantile hedging on equity-linked life insurance contract.
    In chapter 2 and chapter 3, we hedge a single premium equity-linked life insurance contract with a stochastic guarantee from quantile and efficient hedging with a stochastic interest rate respectively. We present the explicit theoretical results for the premium of a contract paying the maximum of two risky asset values at maturity, providing the insured can survive to this date. These results allow the straightforward calculation of survival probabilities for the contract owner, which can quantify the insurance companies’ mortality risk and target their potential clients. Meanwhile, the numerical examples illustrate the corresponding risk management strategies for insurance companies by applying quantile and efficient hedging.
    Chapter 4 analyzes the application of quantile hedging on equity-linked life insurance contracts in the presence of transaction costs. We obtain the explicit expressions for the expected present values of hedging errors and transaction costs. Furthermore, the estimated expected present values of hedging errors, transaction costs and total hedging costs are also computed from a simulation approach to compare with the theoretical ones. Finally, the quantile hedging costs of the contract’s maturity guarantee inclusive of transaction costs are discussed.

  • Subjects / Keywords
  • Graduation date
    Spring 2014
  • Type of Item
    Thesis
  • Degree
    Doctor of Philosophy
  • DOI
    https://doi.org/10.7939/R3DB7VZ50
  • License
    This thesis is made available by the University of Alberta Libraries with permission of the copyright owner solely for non-commercial purposes. This thesis, or any portion thereof, may not otherwise be copied or reproduced without the written consent of the copyright owner, except to the extent permitted by Canadian copyright law.