Traffic Light Options

Peter Løchte
Additional contact information
Peter Løchte: Department of Business Studies, Aarhus School of Business, Postal: The Aarhus School of Business, Fuglesangs Allé 4, 8210 Aarhus V, Denmark, http://www.asb.dk/staff/bs/plj.aspx?page=%7B803EFF10-69F7-4C0F-AEE3-F7F410E4B6F2%7D
Authors registered in the RePEc Author Service: Peter Løchte Jørgensen (plj@econ.au.dk)

No F-2006-08, Finance Research Group Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies

Abstract: This paper introduces, prices, and analyzes traffic light options. The traffic light

option is an innovative structured OTC derivative developed independently by several

London-based investment banks to suit the needs of Danish life and pension (L&P)

companies, which must comply with the traffic light solvency stress test system introduced by the Danish Financial Supervisory Authority (DFSA) in June 2001. This monitoring system requires L&P companies to submit regular reports documenting the sensitivity of the companies’ base capital to certain pre-defined market shocks – the red and yellow light scenarios. These stress scenarios entail drops in interest rates as well as in stock prices, and traffic light options are thus designed to pay off and preserve sufficient capital when interest rates and stock prices fall simultaneously. Sweden’s FSA implemented a traffic light system in January 2006, and supervisory authorities in many other European countries have implemented similar regulation. Traffic light options are therefore likely to attract the attention of a wider audience of pension fund managers in the future. Focusing on the valuation of the traffic light option we set up a Black-Scholes/Hull-White model to describe stock market and interest rate dynamics, and analyze the traffic light option

in this framework.

Keywords: Traffic light solvency tests; regulatory solvency requirements; asset-liability management in pension funds; hedging interest rate and stock price risk; derivatives pricing; Black-Scholes/Hull-White model (search for similar items in EconPapers)
Pages: 34 pages
Date: 2006-11-13
New Economics Papers: this item is included in nep-eec and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.hha.dk/bs/wp/fin/F_2006_08.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to www.hha.dk:80 (No such host is known. )

Related works:
Journal Article: Traffic light options (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hhb:aarbfi:2006-08

Access Statistics for this paper

More papers in Finance Research Group Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark. Contact information at EDIRC.
Bibliographic data for series maintained by Helle Vinbaek Stenholt (hes@asb.dk this e-mail address is bad, please contact repec@repec.org).