Pricing and hedging guaranteed annuity options via static option replication

A. Pelsser*

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

25 Citations (Web of Science)

Abstract

In this paper we derive a market value for with-profits guaranteed annuity options (GAOs) using martingale modelling techniques. Furthermore, we show how to construct a static replicating portfolio of vanilla interest rate swaptions that replicates the with-profits GAO. Finally, we illustrate with historical UK interest rate data from the period 1980 to 2000 that the static replicating portfolio would have been extremely effective as a hedge against the interest rate risk involved in the GAO, that the static replicating portfolio would have been considerably cheaper than up-front reserving and also that the replicating portfolio would have provided a much better level of protection than an up-front reserve. (C) 2003 Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)283-296
Number of pages14
JournalInsurance: Mathematics and Economics
Volume33
Issue number2
DOIs
Publication statusPublished - 20 Oct 2003
Externally publishedYes
Event6th IME Conference - Lisbon, Portugal
Duration: 15 Jul 200217 Jul 2002

Keywords

  • static option replication
  • guaranteed annuity options
  • hedging methodology
  • LIFE-INSURANCE LIABILITIES
  • TERM STRUCTURE
  • INTEREST-RATES
  • VALUATION
  • DERIVATIVES
  • CONTRACTS
  • FRAMEWORK
  • POLICIES

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