The Risk Management of Minimum Return Guarantees

BuR Business Research Journal, Vol. 1, No. 1 May 2008

23 Pages Posted: 31 Jul 2003

See all articles by Antje Brigitte Mahayni

Antje Brigitte Mahayni

Mercator School of Management

Erik Schlögl

University of Technology Sydney (UTS), Quantitative Finance Research Centre; University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management; Faculty of Science, Department of Statistics, University of Johannesburg; Financial Research Network (FIRN)

Date Written: June 5, 2003

Abstract

Contracts paying a guaranteed minimum rate of return and a fraction of a positive excess rate, which is specified relative to a benchmark portfolio, are closely related to unit-linked life-insurance products and can be considered as alternatives to direct investment in the underlying benchmark. They contain an embedded power option, and the key issue is the tractable and realistic hedging of this option, in order to rigorously justify valuation by arbitrage arguments and prevent the guarantees from becoming uncontrollable liabilities to the issuer. We show how to determine the contract parameters conservatively and implement robust risk-management strategies.

Keywords: Minimum return guarantee, defined-contribution pension plans, life-insurance, uncertain volatility, conservative pricing, robust hedging, model misspecification, model risk

JEL Classification: G13, G22, G23

Suggested Citation

Mahayni, Antje B. and Schloegl, Erik, The Risk Management of Minimum Return Guarantees (June 5, 2003). BuR Business Research Journal, Vol. 1, No. 1 May 2008. Available at SSRN: https://ssrn.com/abstract=414282 or http://dx.doi.org/10.2139/ssrn.414282

Antje B. Mahayni

Mercator School of Management ( email )

Lotharstraße 65
Duisburg, Nordrhein-Westfalen 47057
Germany

Erik Schloegl (Contact Author)

University of Technology Sydney (UTS), Quantitative Finance Research Centre ( email )

Ultimo
PO Box 123
Sydney, NSW 2007
Australia
+61 2 9514 2535 (Phone)

HOME PAGE: http://www.schlogl.com

University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management ( email )

Leslie Commerce Building
Rondebosch
Cape Town, Western Cape 7700
South Africa

Faculty of Science, Department of Statistics, University of Johannesburg ( email )

Auckland Park, 2006
South Africa

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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