On Fund Mapping Regressions Applied to Segregated Funds Hedging Schemes under Regime-Switching Dynamics
22 Pages Posted: 14 Apr 2018 Last revised: 21 Jul 2018
Date Written: March 16, 2018
Insurers issuing segregated fund policies apply dynamic hedging to mitigate risks related to guarantees embedded in such policies. A typical industry practice consists in using fund mapping regressions to represent basis risk stemming from the imperfect correlation between the underlying fund and its corresponding hedging instruments. The current note discusses the implications of using fund mapping regressions in a regime-switching framework, such as the potential underestimation of capital requirements. The impact of the latter phenomenon is quantified through simulations calibrated on market data.
Keywords: Basis Risk, Hedging, Segregated Funds, Variable Annuities, Risk Measures, Risk Management, Regime-Switching Models
JEL Classification: G22, G31, G32, C61
Suggested Citation: Suggested Citation