Market Consistent and Sub-Consistent Valuations in Incomplete Markets
41 Pages Posted: 14 Sep 2015 Last revised: 15 Sep 2015
Date Written: September 13, 2015
From January 2016, all insurance companies that are regulated within Solvency II framework will have to value their asset and liabilities using a market-consistent method. This paper studies market-consistent and sub-consistent valuations in incomplete financial markets with two types (type I and II) of market consistency. While market consistency of type I holds under fairly weak assumptions, the type II consistency, which is the usual definition of market consistency in the literature, holds only if the market prices are linear for fully hedged assets. We also characterize the market consistent and sub-consistent evaluators in several different ways. We discuss how market-consistent and sub-consistent valuations can be regarded as a robust approach to hedging and pricing in the presence of market imperfections such as market incompleteness and frictions.
JEL Classification: G11, G13, C22, E44
Suggested Citation: Suggested Citation