Market Value Margin via Mean-Variance Hedging

The final version of this article has appeared as: Tsanakas A., Wüthrich, M., Cerny, A. (2013), 'Market value margin via mean-variance hedging', ASTIN Bulletin, 43(3), p.301-322.

21 Pages Posted: 20 Sep 2012 Last revised: 3 Jan 2014

See all articles by Andreas Tsanakas

Andreas Tsanakas

City University London - Cass Business School

Mario V. Wuthrich

RiskLab, ETH Zurich

Aleš Černý

Cass Business School, City, University of London

Date Written: March 30, 2013

Abstract

We use mean-variance hedging in discrete time, in order to value a terminal insurance liability. The prediction of the liability is decomposed into claims development results, that is, yearly deteriorations in its conditional expected value. We assume the existence of a tradeable derivative with binary pay-off, written on the claims development result and available in each period. In simple scenarios, the resulting valuation formulas become very similar to regulatory cost-of-capital-based formulas. However, adoption of the mean-variance framework improves upon the regulatory approach, by allowing for potential calibration to observed market prices, inclusion of other tradeable assets, and consistent extension to multiple periods. Furthermore, it is shown that the hedging strategy can also lead to increased capital efficiency and consistency of market valuation with Euler-type capital allocations.

Keywords: Cost-of-capital, market consistent valuation, market value margin, mean-variance hedging, Solvency II

Suggested Citation

Tsanakas, Andreas and Wuthrich, Mario V. and Černý, Aleš, Market Value Margin via Mean-Variance Hedging (March 30, 2013). The final version of this article has appeared as: Tsanakas A., Wüthrich, M., Cerny, A. (2013), 'Market value margin via mean-variance hedging', ASTIN Bulletin, 43(3), p.301-322.. Available at SSRN: https://ssrn.com/abstract=2148911 or http://dx.doi.org/10.2139/ssrn.2148911

Andreas Tsanakas (Contact Author)

City University London - Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Mario V. Wuthrich

RiskLab, ETH Zurich ( email )

Department of Mathematics
Ramistrasse 101
Zurich, 8092
Switzerland

Aleš Černý

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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