TY - JOUR
T1 - Parametric mortality indexes
T2 - From index construction to hedging strategies
AU - Tan, Chong It
AU - Li, Jackie
AU - Li, Johnny Siu Hang
AU - Balasooriya, Uditha
PY - 2014/11
Y1 - 2014/11
N2 - In this paper, we investigate the construction of mortality indexes using the time-varying parameters in common stochastic mortality models. We first study how existing models can be adapted to satisfy the new-data-invariant property, a property that is required to ensure the resulting mortality indexes are tractable by market participants. Among the collection of adapted models, we find that the adapted Model M7 (the Cairns-Blake-Dowd model with cohort and quadratic age effects) is the most suitable model for constructing mortality indexes. One basis of this conclusion is that the adapted model M7 gives the best fitting and forecasting performance when applied to data over the age range of 40-90 for various populations. Another basis is that the three time-varying parameters in it are highly interpretable and rich in information content. Based on the three indexes created from this model, one can write a standardized mortality derivative called K-forward, which can be used to hedge longevity risk exposures. Another contribution of this paper is a method called key K-duration that permits one to calibrate a longevity hedge formed by K-forward contracts. Our numerical illustrations indicate that a K-forward hedge has a potential to outperform a q-forward hedge in terms of the number of hedging instruments required.
AB - In this paper, we investigate the construction of mortality indexes using the time-varying parameters in common stochastic mortality models. We first study how existing models can be adapted to satisfy the new-data-invariant property, a property that is required to ensure the resulting mortality indexes are tractable by market participants. Among the collection of adapted models, we find that the adapted Model M7 (the Cairns-Blake-Dowd model with cohort and quadratic age effects) is the most suitable model for constructing mortality indexes. One basis of this conclusion is that the adapted model M7 gives the best fitting and forecasting performance when applied to data over the age range of 40-90 for various populations. Another basis is that the three time-varying parameters in it are highly interpretable and rich in information content. Based on the three indexes created from this model, one can write a standardized mortality derivative called K-forward, which can be used to hedge longevity risk exposures. Another contribution of this paper is a method called key K-duration that permits one to calibrate a longevity hedge formed by K-forward contracts. Our numerical illustrations indicate that a K-forward hedge has a potential to outperform a q-forward hedge in terms of the number of hedging instruments required.
UR - http://www.scopus.com/inward/record.url?scp=84955085649&partnerID=8YFLogxK
U2 - 10.1016/j.insmatheco.2014.10.005
DO - 10.1016/j.insmatheco.2014.10.005
M3 - Article
AN - SCOPUS:84955085649
VL - 59
SP - 285
EP - 299
JO - Insurance: Mathematics and Economics
JF - Insurance: Mathematics and Economics
SN - 1873-5959
ER -