The Risk Management of Minimum Return Guarantees

Antje Mahayni and Erik Schlogl

No 102, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: We analyse contracts which pay out a guaranteed minimum rate of return and a fraction of a positive excess rate, which is specified on the basis of a benchmark portfolio. These contracts are closely related to unit-linked life-insurance/savings plans products and can be considered as alternatives to a direct investment in the underlying benchmark portfolio. The option embedded into the savings plan is in fact a power option, and thus the specification of the "fair" contract parameters is closely related to well known features of these financial derivatives. The key issue, both in order to rigorously justify valuation by arbitrage arguments and to prevent the guarantees from becoming uncontrollable liabilities to the issuer, is the risk management of the embedded options by a tractable and realistic hedging strategy. The long maturity of life-insurance products makes it necessary to lift Black/Scholes assumptions and consider an uncertain volatility scenario, thus explicitly taking into account "model risk". In this context, we show how to determine the contract parameters conservatively and implement robust risk management strategies. This highlights the necessity of a careful choice of guarantees which are granted to the insurance customer and suggests a new role for a type of "bonus account" customary in many life-insurance contracts.

Keywords: minimum return guarantee; defined-contribution pension plans; life-insurance; uncertain volatility; conservative pricing; robust hedging; model misspecification; model risk (search for similar items in EconPapers)
Pages: 30 pages
Date: 2003-06-01
New Economics Papers: this item is included in nep-fin and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Published as: Mahayni, A. and Schlogl, E., 2003, "The Risk Management of Minimum Return Guarantees", BuR - Business Research, 1(1), 55-76.

Downloads: (external link)
http://www.qfrc.uts.edu.au/research/research_papers/rp102.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.qfrc.uts.edu.au/research/research_papers/rp102.pdf [301 Moved Permanently]--> http://www.uts.edu.au/node/51831 [301 Moved Permanently]--> https://www.uts.edu.au/node/51831)

Related works:
Working Paper: The Risk Management of Minimum Return Guarantees (2003)
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:uts:rpaper:102

Access Statistics for this paper

More papers in Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney PO Box 123, Broadway, NSW 2007, Australia. Contact information at EDIRC.
Bibliographic data for series maintained by Duncan Ford (duncan.ford@uts.edu.au).