Local Hedging of Variable Annuities in the Presence of Basis Risk

37 Pages Posted: 7 Jul 2017

See all articles by Denis-Alexandre Trottier

Denis-Alexandre Trottier

Laval University, Faculté d'Administration, Département de Finance et Assurance, Students

Frédéric Godin

Concordia University, Quebec - Department of Mathematics & Statistics; Université Laval

Emmanuel Hamel

Laval University - Ecole d’Actuariat, Students

Date Written: July 4, 2017

Abstract

A method to hedge variable annuities in the presence of basis risk is developed. A regime-switching model is considered for the dynamics of market assets. The approach is based on a local optimization of risk and is therefore very tractable and flexible. The local optimization criterion is itself optimized to minimize capital requirements associated with the variable annuity policy, the latter being quantified by the CVaR risk metric. In comparison to benchmarks, our method is successful in reducing capital requirements. Indeed the proposed local hedging scheme benefits from a higher exposure to equity risk and from time diversification of risk to earn excess return and facilitate the accumulation of capital.

Keywords: Basis Risk, Hedging, Segregated Funds, Variable Annuities, Risk Measures, Risk Management, Regime-Switching Models

JEL Classification: G22, G31, G32, C61

Suggested Citation

Trottier, Denis-Alexandre and Godin, Frédéric and Hamel, Emmanuel, Local Hedging of Variable Annuities in the Presence of Basis Risk (July 4, 2017). Available at SSRN: https://ssrn.com/abstract=2997118 or http://dx.doi.org/10.2139/ssrn.2997118

Denis-Alexandre Trottier

Laval University, Faculté d'Administration, Département de Finance et Assurance, Students ( email )

Pavillon Palasis-Prince
Quebec, Quebec G1K 7P4
Canada

Frédéric Godin (Contact Author)

Concordia University, Quebec - Department of Mathematics & Statistics ( email )

1455 De Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada

Université Laval ( email )

2214 Pavillon J-A. DeSeve
Quebec, Quebec G1K 7P4
Canada

Emmanuel Hamel

Laval University - Ecole d’Actuariat, Students ( email )

Canada

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