Pricing and Hedging Defaultable Participating Contracts with Regime Switching and Jump Risk

Forthcoming, Decisions in Economics and Finance

35 Pages Posted: 16 Dec 2019 Last revised: 27 Mar 2020

See all articles by Olivier Le Courtois

Olivier Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control

Francois Quittard-Pinon

EMLYON Business School

Xiaoshan Su

Beihang University (BUAA)

Date Written: September 18, 2019

Abstract

This paper develops a transform-based approach for the pricing of participating life insurance contracts with a constant or floating guaranteed rate. Our analysis incorporates credit, market (jump), and economic (regime switching) risks, where the evolution of the reference portfolio is described by a regime switching double exponential jump diffusion model. We provide semi-analytical formulas for the contract value by using a Laplace or Laplace-Fourier transform that involves matrix Wiener-Hopf factors. Then, the price is obtained by implementing the matrix Wiener-Hopf factorization and by performing a numerical Laplace and Fourier inversion. By comparing the results with Monte-Carlo simulations, we show that our pricing method is easy to implement and accurate. We also show that the contract with a floating guaranteed rate is riskier but more profitable than the contract with a constant guaranteed rate. Two hedging strategies are introduced to hedge jump and regime switching risks in the participating contracts.

Keywords: Participating life insurance, Credit risk, Regime switching, Jump-diffusion, Matrix Wiener-Hopf factorization

JEL Classification: G13, G22

Suggested Citation

Le Courtois, Olivier Arnaud and Quittard-Pinon, Francois and Su, Xiaoshan, Pricing and Hedging Defaultable Participating Contracts with Regime Switching and Jump Risk (September 18, 2019). Forthcoming, Decisions in Economics and Finance, Available at SSRN: https://ssrn.com/abstract=3488992 or http://dx.doi.org/10.2139/ssrn.3488992

Olivier Arnaud Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control ( email )

23, av. Guy de Collongue
69134 Ecully Cedex
France

Francois Quittard-Pinon

EMLYON Business School ( email )

23, Avenue Guy de Collongue
69134, Ecully
France

Xiaoshan Su (Contact Author)

Beihang University (BUAA) ( email )

37 Xue Yuan Road
Beijing 100083
China

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