Hedging of Variable Annuities under Basis Risk

Bauer Jan ()
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Bauer Jan: University of Mannheim, Schloss, 68131 Mannheim, Germany

Asia-Pacific Journal of Risk and Insurance, 2020, vol. 14, issue 2, 34

Abstract: I study dynamic hedging for variable annuities under basis risk. Basis risk, which arises from the imperfect correlation between the underlying fund and the proxy asset used for hedging, has a highly negative impact on the hedging performance. In this paper, I model the financial market based on correlated geometric Brownian motions and analyze the risk management for a pool of stylized GMAB contracts. I investigate whether the choice of a suitable hedging strategy can help to reduce the risk for the insurance company. Comparing several cross-hedging strategies, I observe very similar hedging performances. Particularly, I find that well-established but complex strategies from mathematical finance do not outperform simple and naive approaches in the context studied. Diversification, however, could help to reduce the adverse impact of basis risk.

Keywords: basis risk; hedging; variable annuities; GMAB (search for similar items in EconPapers)
JEL-codes: G13 G22 G32 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1515/apjri-2019-0040

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