Robust Mean–Variance Hedging of Longevity Risk

17 Pages Posted: 14 Apr 2017

See all articles by Hong Li

Hong Li

Nankai University

Anja De Waegenaere

Tilburg University - Department of Econometrics & OR, Netspar, and CentER

Bertrand Melenberg

Tilburg University - Center for Economic Research (CentER)

Date Written: April 2017

Abstract

Parameter uncertainty and model misspecification can have a significant impact on the performance of hedging strategies for longevity risk. To mitigate this lack of robustness, we propose an approach in which the optimal hedge is determined by optimizing the worst‐case value of the objective function with respect to a set of plausible probability distributions. In the empirical analysis, we consider an insurer who hedges longevity risk using a longevity bond, and we compare the worst‐case (robust) optimal hedges with the classical optimal hedges in which parameter uncertainty and model misspecification are ignored. We find that unless the risk premium on the bond is close to zero, the robust optimal hedge is significantly less sensitive to variations in the underlying probability distribution. Moreover, the robust optimal hedge on average outperforms the nominal optimal hedge unless the probability distribution used by the nominal hedger is close to the true distribution.

Suggested Citation

Li, Hong and De Waegenaere, Anja M.B. and Melenberg, Bertrand, Robust Mean–Variance Hedging of Longevity Risk (April 2017). Journal of Risk and Insurance, Vol. 84, Issue S1, pp. 459-475, 2017. Available at SSRN: https://ssrn.com/abstract=2952793 or http://dx.doi.org/10.1111/jori.12201

Hong Li (Contact Author)

Nankai University ( email )

94 Weijin Road
Tianjin, 300071
China

Anja M.B. De Waegenaere

Tilburg University - Department of Econometrics & OR, Netspar, and CentER ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Bertrand Melenberg

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2730 (Phone)

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