Cross-hedging minimum return guarantees: Basis and liquidity risks

Publikation: Beiträge in ZeitschriftenZeitschriftenaufsätzeForschungbegutachtet


We reveal pitfalls in the hedging of insurance contracts with a minimum return guarantee on the underlying investment, e.g. an external mutual fund. We analyze basis risk entailed by hedging the guarantee with a dynamic portfolio of proxy assets for the funds. We also take account of liquidity risk which arises since the insurer may need to advance funds for performing the hedge. Based on a least-squares Monte Carlo simulation, we study the economic implications of basis and liquidity risks. We demonstrate that both risks may be surprisingly high and show how the design of the contract and the hedging strategy may help to alleviate them.

ZeitschriftJournal of Economic Dynamics and Control
Seiten (von - bis)93-109
Anzahl der Seiten17
PublikationsstatusErschienen - 04.2014
Extern publiziertJa