Parametric mortality indexes

From index construction to hedging strategies

Chong It Tan*, Jackie Li, Johnny Siu Hang Li, Uditha Balasooriya

*Corresponding author for this work

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

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.

Original languageEnglish
Pages (from-to)285-299
Number of pages15
JournalInsurance: Mathematics and Economics
Volume59
DOIs
Publication statusPublished - 2014
Externally publishedYes

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