Dynamic Longevity Hedging in the Presence of Population Basis Risk: A Feasibility Analysis From Technical and Economic Perspectives

Kenneth Q. Zhou, Johnny Siu Hang Li

Research output: Contribution to journalArticlepeer-review

15 Scopus citations

Abstract

In this article, we study the feasibility of dynamic longevity hedging with standardized securities that are linked to broad-based mortality indexes. On the technical front, we generalize the dynamic “delta” hedging strategy developed by Cairns (2011) to incorporate the situation when population basis risk exists. On the economic front, we discuss the potential financial benefits of an index-based hedge over a bespoke risk transfer. By considering data from a large group of national populations, we find evidence supporting the diversifiability of population basis risk. We further propose a customized surplus swap—executed between a hedger and reinsurer—to utilize the diversifiability. As standardized instruments demand less illiquidity premium, a combination of a dynamic index-based hedge and the proposed customized surplus swap may possibly be a more economical (and equally effective) alternative to a bespoke risk transfer.

Original languageEnglish (US)
Pages (from-to)417-437
Number of pages21
JournalJournal of Risk and Insurance
Volume84
DOIs
StatePublished - Apr 1 2017
Externally publishedYes

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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