TY - JOUR

T1 - Valuation of Guaranteed Annuity Options Using a Stochastic Volatility Model for Equity Prices

AU - Pelsser, A.A.J.

AU - van Haastrecht, A.

AU - Plat, R.

PY - 2010/1/1

Y1 - 2010/1/1

N2 - Guaranteed annuity options are options providing the right to convert a policyholder’s accumulated funds to a life annuity at a fixed rate when the policy matures. These options were a common feature in uk retirement savings contracts issued in the 1970’s and 1980’s when interest rates were high, but caused problems for insurers as the interest rates began to fall in the 1990’s. Currently, these options are frequently sold in the us and japan as part of variable annuity products. The last decade the literature on pricing and risk management of these options evolved. Until now, for pricing these options generally a geometric brownian motion for equity prices is assumed. However, given the long maturities of the insurance contracts a stochastic volatility model for equity prices would be more suitable. In this paper explicit expressions are derived for prices of guaranteed annuity options assuming stochastic volatility for equity prices and either a 1-factor or 2-factor gaussian interest rate model. The results indicate that the impact of ignoring stochastic volatility can be significant.

AB - Guaranteed annuity options are options providing the right to convert a policyholder’s accumulated funds to a life annuity at a fixed rate when the policy matures. These options were a common feature in uk retirement savings contracts issued in the 1970’s and 1980’s when interest rates were high, but caused problems for insurers as the interest rates began to fall in the 1990’s. Currently, these options are frequently sold in the us and japan as part of variable annuity products. The last decade the literature on pricing and risk management of these options evolved. Until now, for pricing these options generally a geometric brownian motion for equity prices is assumed. However, given the long maturities of the insurance contracts a stochastic volatility model for equity prices would be more suitable. In this paper explicit expressions are derived for prices of guaranteed annuity options assuming stochastic volatility for equity prices and either a 1-factor or 2-factor gaussian interest rate model. The results indicate that the impact of ignoring stochastic volatility can be significant.

U2 - 10.1016/j.insmatheco.2010.06.007

DO - 10.1016/j.insmatheco.2010.06.007

M3 - Article

VL - 47

SP - 266

EP - 277

JO - Insurance: Mathematics and Economics

JF - Insurance: Mathematics and Economics

SN - 0167-6687

IS - 3

ER -