VALUATION OF GUARANTEED ANNUITY OPTIONS IN AFFINE TERM STRUCTURE MODELS

Chi Chiu Chu and Yue Kuen Kwok ()
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Chi Chiu Chu: Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China
Yue Kuen Kwok: Department of Mathematics, Hong Kong University of Science and Technology, Clear Water Bay, Hong Kong, China

International Journal of Theoretical and Applied Finance (IJTAF), 2007, vol. 10, issue 02, 363-387

Abstract: We propose three analytic approximation methods for numerical valuation of the guaranteed annuity options in deferred annuity pension policies. The approximation methods include the stochastic duration approach, Edgeworth expansion, and analytic approximation in affine diffusions. The payoff structure in the annuity policies is similar to a quanto call option written on a coupon-bearing bond. To circumvent the limitations of the one-factor interest rate model, we model the interest rate dynamics by a two-factor affine interest rate term structure model. The numerical accuracy and the computational efficiency of these approximation methods are analyzed. We also investigate the value sensitivity of the guaranteed annuity option with respect to different parameters in the pricing model.

Keywords: Guaranteed annuity option; affine term structure models; coupon-bond options; stochastic duration; Edgeworth approximation; affine approximation (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (6)

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DOI: 10.1142/S0219024907004160

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