Basis Risk in Variable Annuities

48 Pages Posted: 2 Mar 2020

See all articles by Wenchu Li

Wenchu Li

Temple University - Department of Risk, Insurance & Healthcare Management

Thorsten Moenig

Temple University, Department of Risk, Insurance & Healthcare Management

Maciej Augustyniak

University of Montreal - Department of Mathematics and Statistics

Date Written: February 1, 2020

Abstract

Variable annuities (VAs) are highly popular personal savings and investment products with long-term financial guarantees. The hedging of these guarantees is crucial for VA providers, but is complicated by basis risk, i.e. the discrepancy in returns between the underlying mutual fund and suitable hedging instruments. Enhancing fund mapping methods with data analytic techniques for large sets of VA-underlying mutual funds and mapping instruments, we document that --- even under favorable conditions --- over 25% of the volatility of fund returns cannot be eliminated, no matter how sophisticated the hedge. Our findings persist across model specifications, asset classes, and most Lipper Objective Codes.

Keywords: Variable Annuities, Basis Risk, Mutual Fund, Fund Mapping Techniques, LASSO Regression

JEL Classification: G22, G23, G52, C52, C55, C60

Suggested Citation

Li, Wenchu and Moenig, Thorsten and Augustyniak, Maciej, Basis Risk in Variable Annuities (February 1, 2020). Available at SSRN: https://ssrn.com/abstract=3531307 or http://dx.doi.org/10.2139/ssrn.3531307

Wenchu Li

Temple University - Department of Risk, Insurance & Healthcare Management ( email )

1801 Liacouras Walk
Philadelphia, PA 19122
United States

Thorsten Moenig (Contact Author)

Temple University, Department of Risk, Insurance & Healthcare Management ( email )

Fox School of Business and Management
1301 Cecil B. Moore Ave.
Philadelphia, PA 19122
United States

Maciej Augustyniak

University of Montreal - Department of Mathematics and Statistics ( email )

C.P. 6128, succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

HOME PAGE: http://dms.umontreal.ca/

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