EconPapers    
Economics at your fingertips  
 

Longevity hedge effectiveness: a decomposition

Andrew J.G. Cairns, Kevin Dowd, David Blake () and Guy D. Coughlan

Quantitative Finance, 2014, vol. 14, issue 2, 217-235

Abstract: We use a case study of a pension plan wishing to hedge the longevity risk in its pension liabilities at a future date. The plan has the choice of using either a customised hedge or an index hedge, with the degree of hedge effectiveness being closely related to the correlation between the value of the hedge and the value of the pension liability. The key contribution of this paper is to show how correlation and, therefore, hedge effectiveness can be broken down into contributions from a number of distinct types of risk factors. Our decomposition of the correlation indicates that population basis risk has a significant influence on the correlation. But recalibration risk as well as the length of the recalibration window are also important, as is cohort effect uncertainty. Having accounted for recalibration risk, additional parameter uncertainty has only a marginal impact on hedge effectiveness. Finally, the inclusion of Poisson risk only starts to become significant when the smaller population falls below about 10,000 members over age 50. Our case study shows that, at least for medium and large pension plans, longevity risk can be substantially hedged using index hedges as an alternative to customised longevity hedges. As a consequence, when the hedger's population involves more than about 10,000 members over age 50, index longevity hedges (in conjunction with the other components of an ALM strategy) can provide an effective and lower cost alternative to both a full buy-out of pension liabilities or even to a strategy using customised longevity hedges.

Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17) Track citations by RSS feed

Downloads: (external link)
http://hdl.handle.net/10.1080/14697688.2012.748986 (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Longevity hedge effectiveness: a decomposition (2011) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:quantf:v:14:y:2014:i:2:p:217-235

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RQUF20

Access Statistics for this article

Quantitative Finance is currently edited by Michael Dempster and Jim Gatheral

More articles in Quantitative Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().

 
Page updated 2019-10-17
Handle: RePEc:taf:quantf:v:14:y:2014:i:2:p:217-235