Coherent Pricing of Life Settlements Under Asymmetric Information

26 Pages Posted: 30 Aug 2013

See all articles by Nan Zhu

Nan Zhu

Pennsylvania State University - Smeal College of Business

Daniel Bauer

University of Alabama

Date Written: September 2013

Abstract

Although life settlements are advertised to deliver a profitable investment opportunity with a low correlation to market systematic risk, recent investigations reveal a discrepancy of expected and realized returns. While thus far this discrepancy has been attributed to the (allegedly) poor quality of the underlying life expectancy estimates, we present a different explanation of the seemingly high reported expected returns based on {adverse selection. In particular, we provide a coherent pricing mechanism and pricing formulas in the presence of asymmetric information with respect to the underlying life expectancies. Therefore, our study sheds light on the nature of the “unique risks” within life settlements as recently discussed in the financial press.

Suggested Citation

Zhu, Nan and Bauer, Daniel, Coherent Pricing of Life Settlements Under Asymmetric Information (September 2013). Journal of Risk and Insurance, Vol. 80, Issue 3, pp. 827-851, 2013. Available at SSRN: https://ssrn.com/abstract=2318237 or http://dx.doi.org/10.1111/j.1539-6975.2013.12010.x

Nan Zhu (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States

Daniel Bauer

University of Alabama ( email )

361 Stadium Drive
Tuscaloosa, AL 35487
United States

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