Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk
North American Actuarial Journal, Vol. 18, No. 1, pp. 68-86, 2014
39 Pages Posted: 3 Oct 2013 Last revised: 25 May 2014
Date Written: June 24, 2013
To control downside risk of a defined benefit (DB) pension plan arising from unexpected mortality improvements and severe market turbulence, this paper proposes an optimization model by imposing two conditional value at risk (CVaR) constraints to control tail risks of pension funding status and total pension costs. With this setup, we further examine two longevity risk hedging strategies subject to basis risk. While the existing literature suggests that the excess-risk hedging strategy is more attractive than the ground-up hedging strategy as the latter is more capital intensive and expensive, our numerical examples show that the excess-risk hedging strategy is much more vulnerable to longevity basis risk, which limits its applications for pension longevity risk management. Hence, our findings provide important insight on the effect of basis risk on longevity hedging strategies.
Keywords: defined benefit pension plan, downside risk, basis risk, CVaR, longevity risk hedging
JEL Classification: C61, G11, G23
Suggested Citation: Suggested Citation