Pricing Surrender Risk in Ratchet Equity-Index Annuities under Regime-Switching Lévy Processes

Adam W. Kolkiewicz and Fangyuan Sally Lin

North American Actuarial Journal, 2017, vol. 21, issue 3, 433-457

Abstract: This article presents a numerical method of pricing the surrender risk in Ratchet equity-index annuities (EIAs). We assume that log-returns of the underlying fund belong to a class of regime-switching models where the parameters are allowed to change randomly according to a hidden Markov chain. The defining feature of these models is the fact that in each regime the characteristic function of log-returns is assumed to have an analytical form. The presented method provides an unified pricing framework within this class and includes the recently developed COS method as a particular case. This aspect of the method is particularly useful when pricing Ratchet options embedded in EIAs, for which the COS method exhibits a low rate of convergence. Our numerical results confirm that for models considered in this article the proposed approach improves convergence of the COS method without increasing the computational burden.

Date: 2017
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DOI: 10.1080/10920277.2017.1302804

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