Longevity Bond Premiums: The Extreme Value Approach and Risk Cubic Pricing

41 Pages Posted: 24 Apr 2014

See all articles by Hua Chen

Hua Chen

University of Hawaiʻi at Mānoa

J David Cummins

Temple University - Risk Management & Insurance & Actuarial Science

Date Written: September 1, 2009

Abstract

The purpose of this study is to analyze securitization of longevity risk with an emphasis on longevity risk modeling and longevity bond premium pricing. Various longevity derivatives have been proposed, and the capital market has experienced one unsuccessful attempt by the European Investment Bank (EIB) in 2004. After carefully analyzing the pros and cons of previous securitizations, we present our proposed longevity bonds, whose payoffs are structured as a series of put option spreads. We utilize a random walk model with drift to fit small variations of mortality improvements and employ extreme value theory to model rare longevity events. Our method is a new approach in longevity risk securitization, which has the advantage of both capturing mortality improvements within sample and extrapolating rare, out-of- sample longevity events. We demonstrate that the risk cubic model developed for pricing catastrophe bonds can be applied to mortality and longevity bond pricing and use the model to calculate risk premiums for longevity bonds.

Keywords: securitization; longevity risk; extreme value theory; bond spreads

JEL Classification: G12, G22

Suggested Citation

Chen, Hua and Cummins, J. David, Longevity Bond Premiums: The Extreme Value Approach and Risk Cubic Pricing (September 1, 2009). Insurance: Mathematics and Economics, Vol. 46, No. 1, 2010. Available at SSRN: https://ssrn.com/abstract=2428597

Hua Chen (Contact Author)

University of Hawaiʻi at Mānoa ( email )

2404 Maile Way, E-602e
Honolulu, HI 96822
United States
(808) 956-8063 (Phone)
(808) 956-9887 (Fax)

J. David Cummins

Temple University - Risk Management & Insurance & Actuarial Science ( email )

Fox School of Business and Management
1801 Liacouras Walk.
Philadelphia, PA 19122
United States
215-204-8468 (Phone)
215-204-4712 (Fax)

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