Variable Annuities with High Water Mark Withdrawal Benefit

17 Pages Posted: 14 Dec 2016

Date Written: December 12, 2016

Abstract

In this paper, we develop a continuous-time model for variable annuities allowing for periodic withdrawals proportional to the high water mark of the underlying account value as well as early surrender of the policy. We derive a HJB variational inequality characterizing the minimal superhedging price of such a contract and the worst-case policyholder behavior from an issuer's perspective. Based on these results, we construct a dynamic trading strategy which superreplicates the contract. In addition, we show how early surrender has to be penalized to disincentivize a worst-case policyholder from using this option. To treat the problem numerically, we develop a semi-Lagrangian scheme based on a discretization of the underlying noise process.

Keywords: variable annuities, early surrender, stochastic control, optimal stopping, Hamilton--Jacobi--Bellman variational inequality

JEL Classification: C61, C63, G22, J32

Suggested Citation

Cheridito, Patrick and Wang, Peiqi, Variable Annuities with High Water Mark Withdrawal Benefit (December 12, 2016). Available at SSRN: https://ssrn.com/abstract=2884645 or http://dx.doi.org/10.2139/ssrn.2884645

Patrick Cheridito (Contact Author)

ETH Zurich ( email )

Department of Mathematics
8092 Zurich
Switzerland

Peiqi Wang

Princeton University ( email )

Sherrerd Hall, Charlton Street
Princeton, NJ 08544
United States

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