Cross-hedging minimum return guarantees: Basis and liquidity risks

Stefan Ankirchner, Judith C. Schneider and Nikolaus Schweizer

Journal of Economic Dynamics and Control, 2014, vol. 41, issue C, 93-109

Abstract: We reveal pitfalls in the hedging of insurance contracts with a minimum return guarantee on the underlying investment, e.g. an external mutual fund. We analyze basis risk entailed by hedging the guarantee with a dynamic portfolio of proxy assets for the funds. We also take account of liquidity risk which arises since the insurer may need to advance funds for performing the hedge. Based on a least-squares Monte Carlo simulation, we study the economic implications of basis and liquidity risks. We demonstrate that both risks may be surprisingly high and show how the design of the contract and the hedging strategy may help to alleviate them.

Keywords: Basis risk; Least-squares Monte Carlo; Liquidity risk; Periodic premia; Variable annuities (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:41:y:2014:i:c:p:93-109

DOI: 10.1016/j.jedc.2014.02.010

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