LOCAL HEDGING OF VARIABLE ANNUITIES IN THE PRESENCE OF BASIS RISK

2018 ◽  
Vol 48 (02) ◽  
pp. 611-646 ◽  
Author(s):  
Denis-Alexandre Trottier ◽  
Frédéric Godin ◽  
Emmanuel Hamel
Keyword(s):  
Regime Switching ◽  
Value At Risk ◽  
Capital Requirements ◽  
Optimization Criterion ◽  
Local Optimization ◽  
Conditional Value At Risk ◽  
Variable Annuities ◽  
Basis Risk ◽  
Hedging Strategies ◽  
Risk Metric

AbstractA method to hedge variable annuities in the presence of basis risk is developed. A regime-switching model is considered for the dynamics of market assets. The approach is based on a local optimization of risk and is therefore very tractable and flexible. The local optimization criterion is itself optimized to minimize capital requirements associated with the variable annuity policy, the latter being quantified by the Conditional Value-at-Risk (CVaR) risk metric. In comparison to benchmarks, our method is successful in simultaneously reducing capital requirements and increasing profitability. Indeed the proposed local hedging scheme benefits from a higher exposure to equity risk and from time diversification of risk to earn excess return and facilitate the accumulation of capital. A robust version of the hedging strategies addressing model risk and parameter uncertainty is also provided.

scholarly journals Comparison of Electricity Spot Price Modelling and Risk Management Applications

Energies ◽  
2020 ◽  
Vol 13 (18) ◽  
pp. 4698
Author(s):  
Ethem Çanakoğlu ◽  
Esra Adıyeke
Keyword(s):  
Risk Management ◽  
Regime Switching ◽  
Value At Risk ◽  
Optimization Problems ◽  
Management Tool ◽  
Conditional Value At Risk ◽  
Spot Price ◽  
Hedging Strategies ◽  
Regime Switching Models ◽  
Switching Models

In dealing with sharp changes in electricity prices, contract planning is considered as a vital risk management tool for stakeholders in deregulated power markets. In this paper, dynamics of spot prices in Turkish electricity market are analyzed, and predictive performance of several models are compared, i.e., time series models and regime-switching models. Different models for derivative pricing are proposed, and alternative portfolio optimization problems using mean-variance optimization and conditional value at risk (CVaR) are solved. Expected payoff and risk structure for different hedging strategies for a hypothetical electricity company with a given demand are analyzed. Experimental studies show that regime-switching models are able to capture electricity characteristics better than their standard counterparts. In addition, evaluations with various risk management models demonstrate that those models are highly competent in providing an effective risk control practice for electricity markets.

Hedging of Variable Annuities under Basis Risk

2020 ◽  
Vol 14 (2) ◽  
Author(s):  
Jan Bauer
Keyword(s):  
Financial Market ◽  
Negative Impact ◽  
Mathematical Finance ◽  
Insurance Company ◽  
Hedging Strategy ◽  
Variable Annuities ◽  
Basis Risk ◽  
Hedging Strategies ◽  
Cross Hedging ◽  
Geometric Brownian Motions

AbstractI study dynamic hedging for variable annuities under basis risk. Basis risk, which arises from the imperfect correlation between the underlying fund and the proxy asset used for hedging, has a highly negative impact on the hedging performance. In this paper, I model the financial market based on correlated geometric Brownian motions and analyze the risk management for a pool of stylized GMAB contracts. I investigate whether the choice of a suitable hedging strategy can help to reduce the risk for the insurance company. Comparing several cross-hedging strategies, I observe very similar hedging performances. Particularly, I find that well-established but complex strategies from mathematical finance do not outperform simple and naive approaches in the context studied. Diversification, however, could help to reduce the adverse impact of basis risk.

NATURAL HEDGING IN LONG-TERM CARE INSURANCE

2017 ◽  
Vol 48 (1) ◽  
pp. 233-274 ◽  
Author(s):  
Susanna Levantesi ◽  
Massimiliano Menzietti
Keyword(s):  
Value At Risk ◽  
Long Term Care ◽  
Transition Probabilities ◽  
Parametric Bootstrap ◽  
Conditional Value At Risk ◽  
Risk Minimization ◽  
Product Mix ◽  
Term Care ◽  
Hedging Strategies

AbstractWe investigate the application of natural hedging strategies for long-term care (LTC) insurers by diversifying both longevity and disability risks affecting LTC annuities. We propose two approaches to natural hedging: one built on a multivariate duration, the other on the Conditional Value-at-Risk minimization of the unexpected loss. Both the approaches are extended to the LTC insurance using a multiple state framework. In order to represent the future evolution of mortality and disability transition probabilities, we use the stochastic model of Cairns et al. (2009) with cohort effect under parameter uncertainty through a semi-parametric bootstrap procedure. We calculate the optimal level of a product mix and measure the effectiveness provided by the interaction of LTC stand alone, deferred annuity and whole-life insurance. We compare the results obtained by the two approaches and find that a natural hedging strategy for LTC insurers is attainable with a product mix of LTC and annuities, but including low proportion of LTC.

scholarly journals Financial Risk Control of Hydro Generation Systems through Market Intelligence and Stochastic Optimization

Energies ◽  
2021 ◽  
Vol 14 (19) ◽  
pp. 6368
Author(s):  
Laís Domingues Leonel ◽  
Mateus Henrique Balan ◽  
Dorel Soares Ramos ◽  
Erik Eduardo Rego ◽  
Rodrigo Ferreira de Mello
Keyword(s):  
Stochastic Optimization ◽  
Utility Function ◽  
Value At Risk ◽  
Financial Risk ◽  
Conditional Value At Risk ◽  
Spot Price ◽  
Model Formulation ◽  
Wholesale Market ◽  
Market Intelligence ◽  
Risk Metric

In the competitive electricity wholesale market, decisions regarding hydro generators are generally made under uncertain conditions, such as pool price, hydrological affluence, and other players’ strategies. From this perspective, this work presents a computational model formulation with associated market intelligence and game theory tools to support a decision-making process in a competitive environment. The idea behind using a market intelligence tool is to apply a stochastic optimization model with an associated conditional value at risk metric defining a utility function, which calculates the weight that the agents attribute to each stochastic variable associated with the problem to be faced. Subsequently, this utility function is used to emulate the other agents’ strategies based on their previous decisions. The final step finds the Nash equilibrium solution between a player and their competitors. The methodology is applied to the monthly allocation of firm energy by hydro generators under the current Brazilian regulatory framework. The results show a change in the generators’ behavior over the years, from risk-neutral agents seeking to maximize their return with 88% of decisions based on spot price forecasts in 2015, to risk-averse agents with 100% of decisions following a factor that is directly impacted by the hydrological affluence forecasts in 2018.

scholarly journals Tail Dependence and Risk Spillover from the US to GCC Banking Sectors

Mathematics ◽  
2020 ◽  
Vol 8 (11) ◽  
pp. 2055
Author(s):  
Faisal Alqahtani ◽  
Nader Trabelsi ◽  
Nahla Samargandi ◽  
Syed Jawad Hussain Shahzad
Keyword(s):  
Asset Allocation ◽  
Value At Risk ◽  
Banking Sector ◽  
Banking System ◽  
Tail Dependence ◽  
Spillover Effects ◽  
The United States ◽  
Conditional Value At Risk ◽  
Hedging Strategies ◽  
The Us

This study investigates the structure of the tail dependence between the United States (US) and Gulf Cooperation Council (GCC) banking sectors for the period February 2010 to July 2017. Conditional value at risk and conditional diversification benefits are calculated. The GCC banking sectors show lower tail dependence with the US banking sector. This is confirmed by the fact that GCC banking sectors receive higher downside risk spillover from the US banking system during downside market movements compared to upside risk spillover effects. Interestingly, an equally weighted portfolio of US and GCC banking stocks can provide relatively higher diversification benefits. These findings have implications for portfolio diversification, asset allocation and hedging strategies.

OPTIMAL REINSURANCE WITH LIMITED CEDED RISK: A STOCHASTIC DOMINANCE APPROACH

2013 ◽  
Vol 44 (1) ◽  
pp. 103-126 ◽  
Author(s):  
Yichun Chi ◽  
X. Sheldon Lin
Keyword(s):  
Stochastic Dominance ◽  
Value At Risk ◽  
Piecewise Linear ◽  
Optimization Criterion ◽  
Conditional Value At Risk ◽  
Convex Order ◽  
Optimal Reinsurance ◽  
Reinsurance Treaty ◽  
Stop Loss ◽  
The Cost

AbstractAn optimal reinsurance problem from the perspective of an insurer is studied in this paper, where an upper limit is imposed on a reinsurer's expected loss over a prescribed level. In order to reduce the moral hazard, we assume that both the insurer and the reinsurer are obligated to pay more as the amount of loss increases in a typical reinsurance treaty. We further assume that the optimization criterion preserves the convex order. Such a criterion is very general as most of the criteria for optimal reinsurance problems in the literature preserve the convex order. When the reinsurance premium is calculated as a function of the actuarial value of coverage, we show via a stochastic dominance approach that any admissible reinsurance policy is dominated by a stop-loss reinsurance or a two-layer reinsurance, depending upon the amount of the reinsurance premium. Moreover, we obtain a similar result to Mossin's Theorem and find that it is optimal for the insurer to cede a loss as much as possible under the net premium principle. To further examine the reinsurance premium for the optimal piecewise linear reinsurance policy, we assume the expected value premium principle and derive the optimal reinsurance explicitly under (1) the criterion of minimizing the variance of the insurer's risk exposure, and (2) the criterion of minimizing the risk-adjusted value of the insurer's liability where the liability valuation is carried out using the cost-of-capital approach based on the conditional value at risk.

Comparison of market risk models with respect to suggested changes of Basel Accord

2014 ◽  
Vol 64 (Supplement-2) ◽  
pp. 257-274
Author(s):  
Eliška Stiborová ◽  
Barbora Sznapková ◽  
Tomáš Tichý
Keyword(s):  
At Risk ◽  
Value At Risk ◽  
Risk Estimation ◽  
Market Risk ◽  
Capital Requirements ◽  
Internal Models ◽  
Conditional Value At Risk ◽  
Risk Capital ◽  
Basel Accord ◽  
Capital Charge

The market risk capital charge of financial institutions has been mostly calculated by internal models based on integrated Value at Risk (VaR) approach, since the introduction of the Amendment to Basel Accord in 1996. The internal models should fulfil several quantitative and qualitative criteria. Besides others, it is the so called backtesting procedure, which was one of the main reasons why the alternative approach to market risk estimation — conditional Value at Risk or Expected Shortfall (ES) — were not applicable for the purpose of capital charge calculation. However, it is supposed that this approach will be incorporated into Basel III. In this paper we provide an extensive simulation study using various sets of market data to show potential impact of ES on capital requirements.

ELS Hedging Method based on CVaR Using Stocks Portfolio and Futures

2016 ◽  
Vol 24 (3) ◽  
pp. 423-455
Author(s):  
Kyunghee Lee ◽  
Hyuncheul Lim ◽  
Youngsoo Choi
Keyword(s):  
Value At Risk ◽  
Bimodal Distribution ◽  
Conditional Value At Risk ◽  
Information Ratio ◽  
Shortfall Risk ◽  
Tracking Stocks ◽  
Hedging Strategies ◽  
Delta Hedging ◽  
Step Down ◽  
Policy Proposals

In this paper, we analyze the hedging risk intrinsic in the auto call step down equity linked securities (ELS) based on two underlying indices including HSCEI, which are major products of the ELS market. And we also propose new hedging strategies based on Conditional Value at Risk (CVaR) using stocks portfolio and futures. Due to the non-symmetric bimodal distribution for return of ELS, which comes from the Knock-In (KI) property inherent in step down ELS structure, and inherent shortfall risk in the ELS structure, a local delta hedging strategy has a limit. In addition, hedging using futures are difficult because of 1) frequent roll-over related with HSCEI futures, 2) price difference between underlying index and futures and 3) lack of futures liquidity caused by excessive ELS issue based on HSCEI. As a way to manage these problems, this paper proposes new hedging strategies : First, construct stocks portfolio tracking index using method suggested by Rockafellar and Uryasev (2002), Alexander, Coleman and Li (2006). Second, do hedging by using this stocks portfolio and futures. This paper shows that 1) index-tracking stocks portfolio based on CVaR has a better performance and lower shortfall risk than index by comparing market ratio, information ratio and Sharpe Ratio, and 2) hedging using stocks portfolio is better than futures. As the policy proposals, if ETF, which tracks the underlying indices of ELS based on CVaR, is to be listed on the exchange (KRX), various kinds of product structures for mid-risk-mid-return structured products will be able to develop further, as well as offer more convenience with hedging.

scholarly journals On Fund Mapping Regressions Applied to Segregated Funds Hedging Under Regime-Switching Dynamics

Risks ◽  
2018 ◽  
Vol 6 (3) ◽  
pp. 78 ◽  
Author(s):  
Denis-Alexandre Trottier ◽  
Frédéric Godin ◽  
Emmanuel Hamel
Keyword(s):  
Regime Switching ◽  
Capital Requirements ◽  
Switching Process ◽  
Current Work ◽  
Dynamic Hedging ◽  
Basis Risk ◽  
Market Data ◽  
Switching Dynamics ◽  
Joint Dynamics ◽  
Industry Practice

Insurers issuing segregated fund policies apply dynamic hedging to mitigate risks related to guarantees embedded in such policies. A typical industry practice consists of using fund mapping regressions to represent basis risk stemming from the imperfect correlation between the underlying fund and its corresponding hedging instruments. The current work discusses the implications of using fund mapping regressions when the joint dynamics of the underlying and hedging assets is a regime-switching process. The potential underestimation of capital requirements stemming from the use of a fund mapping regression under such dynamics is discussed. The magnitude of the latter phenomenon is quantified through simulations calibrated on market data.

scholarly journals Commodity Price Correlation And Time Varying Hedge Ratios

2014 ◽  
Vol 30 (4) ◽  
pp. 1053
Author(s):  
Amine Lahiani ◽  
Khaled Guesmi
Keyword(s):  
Stock Market ◽  
Value At Risk ◽  
Price Volatility ◽  
Commodity Price ◽  
Conditional Value At Risk ◽  
Time Varying ◽  
Conditional Correlation ◽  
Dynamic Conditional Correlation ◽  
Hedging Strategies ◽  
Hedge Ratios

<p>This paper examines the price volatility and hedging behavior of commodity futures indices and stock market indices. We investigate the weekly hedging strategies generated by return-based and range-based asymmetric dynamic conditional correlation (DCC) processes. The hedging performances of short and long hedgers are estimated with a semi-variance, low partial moment and conditional value-at-risk. The empirical results show that range-based DCC model outperforms return-based DCC model for most cases.</p>

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