- Hedging endowment assurance products under interest rate and mortality risk
- Amsterdam: Faculteit Economie en Bedrijfskunde
- Document type
- Working paper
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
This paper analyzes how model misspecification associated with both
interest rate and mortality risk influences hedging decisions of insurance companies.
For this purpose, diverse risk management strategies which are riskminimizing
when model risk is ignored come into consideration. The effectiveness of these
strategies is investigated by looking at the distribution of the resulting hedging er-
rors under the combination of both sources of model risk. The analysis is based on
endowment assurances which include an investment element together with a sum
assured. Normally, the customer contributes periodic premiums. Compared to an
upfront premium, this poses an additional risk to the insurance company. Since the
premium payments stop in the case of an early death, it is not known today how
many premium payments will be forthcoming. Theoretically, a loan corresponding
to the present value of the expected delayed premium payments must be asked for
by the insurance company in order to implement his hedging decisions. Therefore,
we also consider how model risk aspects this borrowing decision.
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