Static versus dynamic longevity-risk hedging

Clemente De Rosa, Elisa Luciano and Luca Regis ()

No 403, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: This paper provides the static, swap-based hedge for an annuity, and compares it with the dynamic, delta-based hedge, achieved using longevity bonds. We assume that the longevity intensity is distributed according to a CIR-type process and provide closed-form derivatives prices and hedges, also in presence of an analogous CIR process for interest rate risk. Our calibration to 65-year old UK males shows that – once interest rate risk is perfectly hedged – the average hedging error of the dynamic hedge is moderate, and both its variance and the thickness of the tails of its distribution are decreasing with the rebalancing frequency. The spread over the basic "swap rate" which makes 99.5% quantile of the distribution of the dynamic hedging error equal to the cost of the static hedge lies between 0.01 and 0.04%.

Keywords: longevity risk; static vs. dynamic hedging; longevity swaps; longevity bonds. (search for similar items in EconPapers)
JEL-codes: G22 G32 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2015
New Economics Papers: this item is included in nep-age and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:403

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