Quantile hedging and its application to life insurance

Melnikov Alexander and Skornyakova Victoria

Statistics & Risk Modeling, 2005, vol. 23, issue 4, 301-316

Abstract: The paper develops the method of quantile hedging in a two-factor jump-diffusion market. The exact formulae of the maximal successful hedging set for an option to exchange one asset for another are given. These results are applied to a class of equity-linked life insurance contracts called “pure endowments with a guarantee”. In our setting, the pay-off functions of these insurance contracts are equal to the maximum of two risky assets in a two-factor jump-diffusion model conditioned by the survival status of the insured. The first asset is responsible for the maximal size of future profits, while the second provides a flexible guarantee to the insured. Based on quantile hedging methodology and a generalized Margrabe's formula, the paper describes the valuation and risk management of such mixed finance-insurance instruments.

Keywords: equity-linked life insurance; pure endowment; flexible guarantee; quantile hedging; jump-diffusion model; Margrabe's formula (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (3)

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DOI: 10.1524/stnd.2005.23.4.301

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