Pricing and hedging defaultable participating contracts with regime switching and jump risk

Olivier Le Courtois (), François Quittard-Pinon () and Xiaoshan Su ()
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Olivier Le Courtois: Emlyon Business School
François Quittard-Pinon: Emlyon Business School
Xiaoshan Su: Emlyon Business School

Decisions in Economics and Finance, 2020, vol. 43, issue 1, No 16, 303-339

Abstract: Abstract This paper develops a transform-based approach for the pricing of participating life insurance contracts with a constant or floating guaranteed rate. Our analysis incorporates credit, market (jump), and economic (regime switching) risks, where the evolution of the reference portfolio is described by a regime switching double exponential jump-diffusion model. We provide semi-analytical formulas for the contract value by using a Laplace or Laplace–Fourier transform that involves matrix Wiener–Hopf factors. Then, the price is obtained by implementing the matrix Wiener–Hopf factorization and by performing a numerical Laplace and Fourier inversion. By comparing the results with Monte Carlo simulations, we show that our pricing method is easy to implement and accurate. We also show that the contract with a floating guaranteed rate is riskier but more profitable than the contract with a constant guaranteed rate. Two hedging strategies are introduced to hedge jump and regime switching risks in the participating contracts.

Keywords: Participating life insurance; Credit risk; Regime switching; Jump-diffusion; Matrix Wiener–Hopf factorization (search for similar items in EconPapers)
JEL-codes: G12 G13 G32 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s10203-020-00276-w

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