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Static versus dynamic longevity­ risk hedging

De Rosa, Clemente and Luciano, Elisa and Regis, Luca Static versus dynamic longevity­ risk hedging. Working Paper #403/2015 Collegio Carlo Alberto ISSN 2279-9362.

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This paper provides the static, swap-based hedge for an annuity, and compares it with the dynamic, delta-based hedge, achieved using longevity bonds. We assume that the longevity intensity is distributed according to a CIR-type process and provide closed-form derivatives prices and hedges, also in presence of an analogous CIR process for interest rate risk. Our calibration to 65-year old UK males shows that – once interest rate risk is perfectly hedged – the average hedging error of the dynamic hedge is moderate, and both its variance and the thickness of the tails of its distribution are decreasing with the rebalancing frequency. The spread over the basic "swap rate" which makes 99.5% quantile of the distribution of the dynamic hedging error equal to the cost of the static hedge lies between 0.01 and 0.04%.

Item Type: Working Paper (Working Paper)
Uncontrolled Keywords: longevity risk, static vs. dynamic hedging, longevity swaps, longevity bonds JEL classification G22, G32
Subjects: H Social Sciences > HB Economic Theory
Q Science > QA Mathematics
Research Area: Economics and Institutional Change
Depositing User: Users 53 not found.
Date Deposited: 23 Mar 2015 14:18
Last Modified: 23 Mar 2015 14:20
URI: http://eprints.imtlucca.it/id/eprint/2635

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