A Multivariate Model of Strategic Asset Allocation with Longevity Risk
Carnegie Mellon University - David A. Tepper School of Business
Audencia Nantes School of Management
Carlo A. Favero
Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)
Bocconi University, IGIER and CAREFIN
May 22, 2014
This paper proposes a framework to evaluate the impact of longevity-linked securities on the risk-return trade-off for traditional portfolios. Generalized unexpected raise in life expectancy is a source of aggregate risk in the insurance sector balance sheets. Longevity-linked securities are a natural instrument to reallocate these risks by making them tradable in the financial market. This paper extends the strategic asset allocation model of Campbell and Viceira (2005) to include a longevity-linked investment in addition to equity and fixed income securities and describe the resulting term structure of risk-return trade-offs. The model highlights an unexpected predictability pattern of the survival probability estimates. The empirical valuation of the market price of longevity risk, based on prices for standardized annuities publicly offered by US insurance companies, confirms that longevity linked securities offer cheap funding opportunities to asset managers willing to leverage their investment portfolio.
Number of Pages in PDF File: 48
Keywords: Longevity Risk, Strategic Asset Allocation
JEL Classification: G11, G12, G22working papers series
Date posted: May 24, 2014
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