TY - JOUR

T1 - Cross-hedging minimum return guarantees

T2 - Basis and liquidity risks

AU - Ankirchner, Stefan

AU - Schneider, Judith C.

AU - Schweizer, Nikolaus

PY - 2014/4

Y1 - 2014/4

N2 - 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.

AB - 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.

KW - Basis risk

KW - Least-squares monte carlo

KW - Liquidity risk

KW - Periodic premia

KW - Variable annuities

KW - Management studies

UR - http://www.scopus.com/inward/record.url?scp=84897524746&partnerID=8YFLogxK

U2 - 10.1016/j.jedc.2014.02.010

DO - 10.1016/j.jedc.2014.02.010

M3 - Journal articles

AN - SCOPUS:84897524746

VL - 41

SP - 93

EP - 109

JO - Journal of Economic Dynamics and Control

JF - Journal of Economic Dynamics and Control

SN - 0165-1889

ER -