Longevity hedging 101: A framework for longevity basis risk analysis and hedge effectiveness

Guy Coughlan, Marwa Khalaf-Allah, Yijing Ye, Sumit Kumar, Andrew Cairns, David Blake and Kevin Dowd

MPRA Paper from University Library of Munich, Germany

Abstract: Basis risk is an important consideration when hedging longevity risk with instruments based on longevity indices, since the longevity experience of the hedged exposure may differ from that of the index. As a result, any decision to execute an index-based hedge requires a framework for (1) developing an informed understanding of the basis risk, (2) appropriately calibrating the hedging instrument, and (3) evaluating hedge effectiveness. We describe such a framework and apply it to a U.K. case study, which compares the population of assured lives from the Continuous Mor- tality Investigation with the England and Wales national population. The framework is founded on an analysis of historical experience data, together with an appreciation of the contextual relationship between the two related populations in social, economic, and demographic terms. Despite the different demographic profiles, the case study provides evidence of stable long-term relationships between the mortality experiences of the two populations. This suggests the important result that high levels of hedge effectiveness should be achievable with appropriately cali- brated, static, index-based longevity hedges. Indeed, this is borne out in detailed calculations of hedge effectiveness for a hypothetical pension portfolio where the basis risk is based on the case study. A robustness check involving populations from the United States yields similar results.

Keywords: Longevity risk; basis risk; hedge effectiveness (search for similar items in EconPapers)
JEL-codes: G22 G23 J11 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-age
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (58)

Published in North American Actuarial Journal 2.15(2011): pp. 150-176

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/35743/1/MPRA_paper_35743.pdf original version (application/pdf)

Related works:
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:pra:mprapa:35743

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().