Optimal Dividends and ALM Under Unhedgeable Risk
Roger J. A. Laeven
Tilburg University - Department of Econometrics and Operations Research, and CentER
Maastricht University; Netspar
January 28, 2010
In this paper we develop a framework for optimal investment decisions for insurance companies in the presence of (partially) unhedgeable risk. The perspective that we choose is from an insurance company that maximises the stream of dividends paid to its shareholders. The policy instruments that the company has are the dividend policy and the investment policy. Using stochastic control theory, we derive simultaneously the optimal investment policy and the optimal dividend policy, taking the insurance risks to be given. We study the trade off between investing in the optimal hedge portfolio and the fully diversified portfolio. We show next how the pricing of unhedgeable risk can also be embedded in our framework. Finally, we derive the distribution of the time of bankruptcy and demonstrate its usefulness in calibrating the model.
Number of Pages in PDF File: 25
Keywords: Optimal dividends, ALM, Unhedgeable risk, Stochastic control
JEL Classification: G22, G31, G35working papers series
Date posted: February 15, 2010
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