On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics

Denis-Alexandre Trottier, Frédéric Godin and Emmanuel Hamel
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Denis-Alexandre Trottier: Faculté des Sciences de l’Administration, Université Laval, Québec, QC G1V 0A6, Canada
Frédéric Godin: Department of Mathematics and Statistics, Concordia University, Montréal, QC H3G 1M8, Canada
Emmanuel Hamel: École d’Actuariat, Université Laval, Québec, QC G1V 0A6, Canada

Risks, 2018, vol. 6, issue 3, 1-15

Abstract: Insurers issuing segregated fund policies apply dynamic hedging to mitigate risks related to guarantees embedded in such policies. A typical industry practice consists of using fund mapping regressions to represent basis risk stemming from the imperfect correlation between the underlying fund and its corresponding hedging instruments. The current work discusses the implications of using fund mapping regressions when the joint dynamics of the underlying and hedging assets is a regime-switching process. The potential underestimation of capital requirements stemming from the use of a fund mapping regression under such dynamics is discussed. The magnitude of the latter phenomenon is quantified through simulations calibrated on market data.

Keywords: basis risk; hedging; segregated funds; variable annuities; risk measures; risk management; regime-switching (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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